Buying endowments versus buying term plans and mutual funds

In 2022,in light of the global health crisis that struck in 2020, having an insurance policy is a necessity. While health was, and will always be the real wealth, the pandemic around the globe reinstated its importance. Planning for your future requires you to include life insurance as a part of your financial portfolio. This ensures you are prepared for any unexpected curveball that life might throw at you and your family. Hence, in any financial plan, insurance finds core importance.

Among the several types of insurance plans, there are two broad categories. One, pure life policies that deal with insurance as it was fundamentally designed for — financial protection of your dependents, and second, insurance policies that also have an investment component included with cover for protection of your life. Endowment plans are an example of the latter type of insurance plan.

Endowment plans V/s Term insurance plans

Endowment policies offer dual benefits of protection for your life, along with savings. The premiums for these plans include a risk cover component and an investment component in one. In the event the policyholder outlives the tenure of the endowment plan, the insurance company offers survival benefits, which include a bonus component too. The payout can either be lumpsum or by way of systematic payments depending on the terms of the insurance contract.

Term insurance policies, or pure life cover plans, offer nothing but protection for your life to the nominees of the insurance plan. The entire premium for these plans is apportioned towards insuring your life and no maturity benefits are available in case the policyholder outlives the period of insurance cover. Hence, the premium is a sunk cost in the case of term insurance plans. Since term plans offer only life cover, the premiums are much lower.

The preference for an endowment policy

Traditionally when insurance was sold in India, it was either by a neighbour who was the typical LIC agent who pitched you a policy or your financial advisor that doubled up as an insurance agent. Moreover, there wasn’t much awareness about equity investing, and hence, mutual funds were struggling to make a mark.

With limited investment opportunities available in the past, insurance policies were considered reliable investment options. Hence, policies that offered returns, like an endowment life insurance plan acted as an investment option. The investors that looked at life insurance policies thought them to be a source of risk cover along with investment. Thus, endowment plans were largely preferred in the past.

Term plans in comparison to an endowment policy

The narrative around life insurance plans doubling up as an investment is slowly changing with an increasing preference for term insurance plans. Term insurance plans are a smarter way to manage the risk. While the basics of financial planning recommend keeping your investments and insurance separate, endowment plans fail at it. Term insurance plans, on the other hand, mark the check. Insurance must also be seen as a risk management product and nothing else.

A term insurance policy is beneficial whichever way you look at it. Since the policy focuses on providing life cover only, the entire premium is directed towards it. Hence, the premium for term plans is low even when you seek a higher sum assured.

In the past, Indians underinsured themselves. Now with the growing importance of insurance cover, more people are opting for sum-assured values that are 10 to 15 times their current annual income. This ensures the family can avoid financial troubles even in the absence of the policyholder.

What about investments?

The standard reason to avoid a term plan is that a policyholder misses out on income from investments. While endowment plans allow the policyholder to receive maturity benefits, as well as participate in a bonus that is paid at the end of the policy tenure, there is no such payout for term plans.

A rational way to make investments is by investing in mutual funds. The amount of premiums you end up saving by purchasing a term insurance policy can be invested routinely in Systematic Investment Plans or SIPs. Since SIPs are available in different types based on your risk appetite, you can choose a fund that fits well with the investment objective, goal, and horizon.

Hence, when you combine term insurance plans with mutual fund investments, they might seem to give higher returns to meet your financial objectives while having coverage for the maximum period of your life. To know how much premiums are charged for term insurance plans based on the specific criteria, you can make use of a life insurance premium calculator.

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