Nine things you should know before investing in endowment policies

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Endowment plans are one of the popular ways of investing in insurance policies. These plans offer a combination of insurance and investment, where the sum assured is paid along with accrued bonus at the end of the term of the policy. Though these plans look simple, you need to know how they work before investing. Here are nine things you should know before investing in endowment plans:

Goal-based investment

These are life insurance policies that apart from offering a cover also allows one to save regularly over a specific period of time that helps in meeting the long-term goals of the policyholder. Before investing, understand the type of endowment plans whether it is money-back, whole life or any other type of plan. Under money back plans, a regular amount is paid after a certain number of years as a bonus and is suitable for conservative investors. Whole life plans are mostly used more for estate planning where maturity amount is paid to nominees after the death of the policyholder.

Bonus

Endowment plans classify as participating (with-profit) policies, which take part in the investment profits of the insurance company. The profit gets shared with policyholders in the form of bonus payments. The bonuses are distributed as a percentage of the sum assured and are generally announced at the end of every financial year. On the other hand, non-participating plans such as term insurance do not take part in the profits of the insurance company.

Returns

Traditional plans are not the cheapest option to buy life insurance. The return from such policies is generally in the range of 5 to 7%. Given the high rate of inflation, it suits conservative investors who want the safety of capital over return. Unit linked insurance plans on the other hand give you a chance to invest in equities, which tend to give higher returns over the long term.

Non-transparent

Unlike Ulips, endowment plans do not give you a cost structure. They also do not have an upper capping for the expenses allowed to be deducted from Ulips. This makes endowment non-transparent as you are not aware of how much money gets deducted towards expenses. On the other hand, ULIPs have become transparent now, as ULIP charges are capped at 3% of gross yield for policies with a term of up to 10 years and 2.25% for those with a term of more than 10 years. Moreover, Ulip charges are broadly classified under these four heading- allocation charges, fund management charges, policy administration charges and mortality charges.

High surrender charges

Endowment policies are long term policies, where you commit to paying for the term of at least 5-10 years. If you surrender the policy midway, you probably get a very small portion of your investment because surrender value is generally around 30%-40% of the total premium paid so far. Moreover, on surrendering the policy you lose the life cover associated with the policy immediately.

Taxability

Endowment plans are eligible for deduction under Section 80C of the Income-Tax Act, subject to the limit of Rs 1.5 lakh. Moreover, the maturity amount is fully tax-free in endowment plans, which gives it an advantage over Ulips. Under Ulips, in case the annual premium exceeds Rs 2.50 lakh, the maturity amount becomes taxable.

Paid-up policy

If you are in a cash crunch situation, then you can convert it into a paid-up policy. In this, the insurance company is not liable to pay the full sum insured, and only a reduced maturity value is paid either on the maturity of the policy or at the death of the policyholder. Typically, the paid-up maturity value is more than the surrender value.

A lapsed policy can be made a paid-up policy, where the sum insured is reduced to an amount based on the number of premiums already paid.

Paid-up value: [(number of premiums paid ÷ total premiums payable) × sum insured] + bonus

Investment

Premiums paid by policyholders get pooled in a life fund. The money lying in this fund gets invested in government securities with small exposure to equities. This fund is also used to pay claims. Based on the claims experience and returns it generates, the insurer then distributes a part of its surplus in the form of a bonus. The policyholder receives 90% of the profits as the bonus and the remaining 10% of the surplus is kept for shareholders.

Loan facility

Last, but not the least, a loan can be taken against the endowment policies without any collateral as and when needed.