Term Vs Endowment Insurance Policies

Another financial year end is nearing. Just like last year, I started thinking about saving some tax. [Not through any illegal means] Last year I was too late and I couldn’t save much of it. So I was determined about not to regret later. But to start with, I am really poor in financial management. All I know was only some type of investments/savings [Financial management gurus, please forgive me if I am misusing any technical terms] are eligible for tax savings under some section [80C I think] and a wise advice also “Diversify your investments/savings”.

But for that, I need to know what kind of investments are there. The main ones are mutual funds, life insurances, public provident fund. These will serve my purpose of saving tax very well I think, so I confined my research to these. Now, based on my research, here is something about the insurance policies I want to share with others.
A word of warning: I am completely new to this kind of stuff and what I am writing here is my opinion only. Many people argued against this approach with many other views and facts. So decide wisely. I am not that good with technical terms, I am explaining in ‘layman’s’ terms.
There are 3 main types of insurances
1. Endowment Policies [With money back ]
2. Term Policies [Without money back]
3. ULIP type
I don’t know much about the third type because almost all the articles I read or people I talked to [including a financial consultant] said linking your insurances with mutual funds is not a good idea.
Now, I will explain the other two with an example. Suppose you want to take insurance with a sum assured of 5 lakhs [You will get this amount in the case of your death during that period] and say, for a period of 20 years. [Assuming your age is 25]
In the first type, you give the insurance company, a premium of 25,000/- to 27000/- per year for 20 years. If something happens to you in that period, you will get the 5 lakhs for sure, plus bonus. These are endowment policies.
In the second type, what happens is, you pay the premium for the same 20 years, and in the end you won’t get anything back. You will get the sum assured, only if something ‘bad’ happens to you in that period. Ok, now why you need to take such a policy? Here come the point, the premium you will be giving, will be much less than the other one, only around 1200/- per year. These are known as the term policies.
Now let’s compare them. For that just have a look at the excel sheet [I too hate excel sheets, but just look at the first and last figures] here.
Assume you are putting 25500/- for 20 years in the first type of policy. With a bonus of 5% [it varies every year and the max is 4.5% (from LIC)], at the end of 20 years, what you will get is 885,340.92/-. Now consider you are going for a term policy and putting around 1200/- per year and remaining 24300/- [25500 - 1200] in PPF [which will give 8% interest]. Then look at your final earnings, 1,200,976.99/-. And the difference is, 315,636.07/-. And that is not a small difference. There are some more advantages too. Consider you want to go for insurance worth 20lakh. You will have to pay around 1lakh per year for 20 years which is nearly impossible [for guys like me]. But the other case, you only have to pay around 3800/-.
My argument is like this, it’s always better to have an insurance, we cannot say what will happen to us and when. So, insurance is insurance and savings is savings, never combine them together. 1200/- per year is not much. With 20 years you are spending 24000/-, but gaining much more from some other form of savings. [Here I took the example of PPF, and I assume you know that there are many schemes which will give you much more returns] And the agents don’t promote the term policies much because their commission is based on the premium you are paying. So next time when some one says “why do you want to pay for 20-25 years and not get back anything?”, think the other way or try to get a good look at the big picture.
Hope this will help some one who is worried about which insurance policy to take. And above all, next year by this time, I am sure that I will be reading this to know what a term policy is and what an endowment policy is.
footnote:
The individual policies differ in the details and all, but the basic concept is same. Also, for term policies, you won’t get much tax exemption since the premium you are paying is less. If anyone want the excel sheet, please feel free to ask me. The premium amount is taken from LIC/SBI premium calculator.
http://www.licindia.com/premium_calculator.htm
http://www.sbilife.com/sbilife/application?pageid=Services&ServicesId1=calculateprem

Also, I would like to thank all the people who helped me writing this blog, especially my colleague who gave me that excel sheet and explained it. ;)