Why you should not go for traditional insurance plans

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With the rise in uncertainties due to Covid-19 many people have turned to traditional plans that offer guaranteed returns along with capital protection. Consider this: In a traditional plan with the policy term of 11 years where you pay Rs 60,000 each year for the first 10-years you get an annual income of Rs 58,710 for the next 25 years the net return works out to 6% over the 36-years period. Will you be fine with 4 to 6 % of return for the tenure as long as 37 years when you can earn around 4% more from a savings account? Is it worth investing for so long in traditional plans?

What are traditional plans?

They are classified as participating and non-participating plans. Participating plans pay bonus amounts to policyholders based on their profitability, based on per thousand of sum assured such as endowment, money-back or whole life plan. A newer version is a guaranteed income plan where you pay for a specified period and then start receiving regular income for another specified period. These are non-participating plans, which instead of declaring a bonus offer a fixed return. The premiums are based on the entry age, the life coverage, and the period for which coverage is required.

Reasons why you should not go for traditional plans

Low return: The traditional insurance plans offer an average return of 4-6% per annum because of the investment structure they are allowed to invest in. Under the Insurance Act, these plans have to invest not less than 25% in central and state government securities. Not less than 15 % in infrastructure and not more than 35 % in approved and other than approved investments. Moreover, there are commission charges in the range of 33 to 5% depending on the policy term and year of premium payment.

Low flexibility: Most of the traditional plans do not allow partial withdrawals. So it is very important to link it with your long-term goals if you still want to buy them. They generally allow loans after 3 years which is around 30% of the surrender value of the policy. But again surrender value is 30-50% of the total premium paid, suggesting you will get a minuscule amount if opt for a loan.

Costly exit: The midway exit is very costly in traditional plans. If you have already bought it ensure to run it till maturity. For products with a premium paying term of less then than 10 years and % if surrendered between the 4th and 7th the surrender value is 50%, which means you will receive half of your investment. It is 30% of the total premiums paid if surrendered between the 2nd and 3rd year.

Limited cover: The sum assured offered with traditional plans may not be adequate to cover your needs as they offer just the basic minimum cover to comply with the legal framework. The minimum sum assured limit is 10 times the annual premium for people below 45 years and 7 times for people above 45 years. It is always good to buy a pure term cover of at least 10 times your annual salary.

If you still want to go for traditional plans make sure you link with your long-term goals.