There are dangers of comparing financial products because each product is designed for different purpose and needs. But comparisons are tools to help us arrive at decisions that account for our needs and suitability.
We often hear how life insurance products give low returns compared to other products and it is partly true. However after combining the insurance and tax saving component of the product, the resulting combination is a potent one. Let us find how the tax saving component makes a big difference in the total returns of a life insurance product.
We take the example of LIC’s endowment plan (Table 14) and compare it with tax saving bank’s deposits. While bank deposits earn a return of around 8.5-9%, the return on a life insurance product is generally below 6%. However, let’s dig a bit more and find the returns after applying tax benefits and the insurance component.
Bank’s Tax Saving Deposits (30.9% Marginal Tax Bracket)
Bank Tax Savings usually earn about 8.5% p.a. compounding quarterly giving an effective annual return of 8.774796% compounded annually. The Investment is eligible for Income Tax Rebate @ 30.9% i.e. Rs30,900 in the case considered.
However the interest in case of Bank Tax Savings Scheme is taxable at marginal tax rate of 30.9%.
Bank Tax Savings FDR’s are available for terms 5 to 10 years. We have taken the example for a 10-year term. We use a FDR Term for 10 years so that it can be compared LIC’s 10 year Endowment Assurance with a Sum Assured of Rs9,50,000 + Term Rider for Rs1,00,000 so that the Premium of Rs97,303 for the Plan is within 10% of the Capital Sum Assured of Rs10,50,000 (Rs9,50,000 basic SA + Rs1.00,000 Term Rider). Both the Schemes are eligible Income Tax Rebate @30.9% of the
Contributions.
Bank FDR’s usually come with 2 options;
Option 1
Cumulative option with a Maturity Value of Rs2,31,890 where the investment is Rs1,00,000. The accumulated interest is Rs1,31,890 and the tax thereon is Rs40,750 reducing the Maturity Value of Rs2,31,890 to Rs1,91,140 (after tax). However, the Investment of Rs1,00,000 qualifies for tax Rebate of 30,900 (30.9%) and the net investment reduces to Rs69,100 (1,00,00 – 30,900). What this means is that a net outgo of Rs69,100 gives a net income of Rs1,91,140. The true return under the scheme is 10.7101% compounded annually. This is presented and tallied as “10-Year Bank FDR @ 8.774796% p.a Cumulative”.
Option 2
The interest on the Bank Tax Savings FDR is paid out annually @ 8.774796%. The Annual interest is Rs8,774.50. The tax @ 30.9% is Rs2,711.50 and the net interest in hand is Rs6,303). The true return under this option is presented and tallied as “10-Year Bank Tax Savings FDR @ 8.774796 annual Interest Payout”. The True Return is 11.3977 compounded annually.
LIC’s Endowment Plan
14-10 with Term Rider
We look at LIC’s 10-Year Endowment with Profits for a Basic Sum Assured of Rs9,50,000 with a term Rider for Rs1,00,000. The Annual Premium is Rs 97,303. Bonuses assumed at Current Rate of 3.4% p.a.. The Maturity Value is Rs13,23,000. And this is tax-free. True return under plan is 12.0198% tax-free compounded annually.
Compare this with Bank Tax Savings Scheme of 10.7101% under Cumulative option and 11.3977% compounded annually.
And we have not taken credit for the Risk Cover Cost into account and is the RCC (the Reinforced Cement Concrete) of any investment strategy!
14-10 with Term Rider Less Risk Cover Cost
The Term Rider Premium for Rs1,00,00 at Age 30 for 10 years Rs234. The Basic Sum Assured is Rs9,50,000 for the 10-year term. For want of a better method, it is assumed that the average Basic Sum Assured is Rs4,75,000 and the Term + Rs1,00,000 = Rs5,75,000. Risk Cover Cost for Plan works to be:
5.75 x 234 = Rs1,346.
The investment is Rs97,303 – Rs1,346 = Rs95,957.
The Maturity Value continues to be Rs13,23,000. The True Return under Policy is 12.2629% compounded annually:
Summing Up
10-Year Bank Tax Savings IRR = 10.7101%
10-Year Bank Tax Savings IRR = 11.3977%
LIC’s 10-Year Endowment with Profits = 12.0198%
LIC’s 10-Year Endowment with Profits without Risk Cover Cost = 12.2629%
If you are looking for tax-planning with good return, please do contact us @7200039282 for