Buying Insurance Or Pension Plan for tax-savings: Finance Trading Times

Buying Insurance Or Pension Plan for tax-savings

Tens of insurance plans, Pension Plans (Retirement Plans) and health policies are available in India for purchase. Additionally, they also give you the implicit tax benefit, i.e. the premium you pay – i.e. the amount you contribute towards them – is exempted from tax. Looking at the way people keep talking about the tax and tax-saving issues, it seems that taxation is one of the biggest problems of the salaried individuals. Some day or the other, individuals end up buying some such policy. However, the primary purpose of buying such policies is not investment and security for future, but savings of tax. In this article, I’ll try to highlight some of the fine details of these different investment tax saving schemes.

In almost all of my articles, I could not control myself from partially touching the psychology of investment and trading. In each article, I’ve very briefly talked about the way people behave while taking financial decisions – be it trading or investing or buying things. One thing I want to stress here is that I am not a good student; I don’t like studies very much. When I finished my Bachelors in engineering, I had no idea that someday I will be going for Masters that too with specialization in finance, investment and trading. I went to a management school thinking that I will specialize in stock trading and make enormous amounts of money. However, the most interesting topic that I liked during my finance studies was behavioral finance. Though I don’t have any plans of studying further as of now, but in case I go for further studies, it will be a Ph.D. in behavioral finance :- )

The reason for quoting the above is that the issues of taxation, insurance, retirement planning, or buying education policies for your beloved children, are all driven by psychological biases. The ambience is created by the so-called AGENTS, who are ready to knock at you door or call you on your cell any time during the 24 hour period. All they are interested in is their commission. What they sell to you is not their recommendations, but their headaches of earning a living through commissions that they earn for sale of policies. TAX SAVING is the biggest buzz word used by these people finally making you feel that it is important to save tax and buy some such policy.

A brief introduction to the following:

  1. Insurance Policy: Invest monthly/quarterly/six-monthly/yearly/one-time
    1. Returns in case of accidents
    2. Returns in case of loss of life
    3. Returns upon maturity of policy
  2. Pension Policy/Retirement Policy: Invest monthly/yearly
    1. Returns in lump-sum when you retire
    2. Returns as a monthly income when you retire till either 75 years of age or till your death
  3. Education benefit policy: Invest for 10/15/20 years
    1. Returns as lump-sum amount when the child is eligible for entering the college – aimed to pay for education fee
  4. Health Insurance: monthly/quarterly/six-monthly/yearly/one-time
    1. Refund of Hospital bill charges in case of hospitalization

Most of these plans, from LIC, ICICI Prulife, BAJAJ Alliance, HDFC and other insurance firms come with an additional benefit of tax saving! This is the buzz word that makes you buy them.

But are these investment options or better to say tax-saving options, really worth considering?

Have a look at what I did in 2003. It was February 2003. It was the time for financial year ending and I received the consolidated tax-sheet from the accounts department – showing a high amount of income tax, which made me worried – why should I pay such a high amount of tax, when there are so many tax-saving options available! The situation in my office among colleagues was similar. Irrespective of the high salary we were earning, we still could not digest the slightly higher amount on the tax-sheet. Result: One person calls the insurance agent and all of us line up to talk to him.

Very smartly, he introduces us the ICICI Prulife Pension policy, dictating us the benefit of tax-saving. Invest 10K, save 30% tax as 3K, your money managed by PROFESSINALS, so good returns guaranteed. What he did not tell us was that a significant portion of money would go as ADMINISTRATION CHARGES. When I, and many more colleagues, bought this policy, this was the state of administrative charges:

Policy Duration: 25 years (can be withdrawn after 3 years)

Admin Charges:

Year 1: 18% (Yes, that’s right – 18%. For 10K investment, that means 1800 Rs. goes towards admin charges, so effectively only 8200 Rs. are invested for you)

Year 2: 10%

Year 3: 7.5%

Year 4 onwards : 4%

Recently, I heard that the first year charges for the same policy have been hiked to 20% (not very sure about this)

So, when you buy this policy, you may save 30/20/10% of tax, depending upon your tax-bracket. However, even with 30% tax bracket, 18% is gone in the very first year. That leaves you with only 12% benefit that too with a lock in period of 3 years.

In case I decide to withdraw my policy after 3 years, I invest 3*10K = 30K. I get tax benefit of 30% = 30% * 30K = 9K. However, I pay a total of 35.5% of tax, averaging to almost 12% each year. It means that when I pay 10K each year for minimum period of 3 years, of my 10K, only 8800 Rs were invested. Remaining 1200 were taken up by these GENTLEMEN who manage my money PROFESSIONALLY. At the end of 3 years, though I invest a total of 30K, my actual investment is only 8800*3= approximately 26.4K Rs. I gain 30% on tax savings, which amounts to 9K, bringing the total to 35.4K Rs. Now, ASSUMING that the managers managing my investments give me a mere 5% returns each year.

So my investment in this policy will grow as follows:


Previous Year Carryforward (a)

This Years investment (b)

Total Investment (a+b)

Return

Total Return

Year 1

0

8,200.00

8,200.00

5%

8,610.00

Year 2

8,610.00

9,000.00

17,610.00

5%

18,490.50

Year 3

18,490.50

9,275.00

27,765.50

5%

29,153.78

Hence at the end of 3 years, I will have a total of 29154 Rs, if my manager gives me a return of 5%. Add to this the tax benefit of 3K each year, amounting to 9K, then the total becomes 29154+9K = 38,154 Rs.

Following a simple average concept, my 30K has become 38.154K, giving me a total return of 8,154 Rs in 3 years, and simple average over 3 years = 8154/3 = 2718 Rs., making it a 27.18% average return.

Now have a look an alternate investment in Tax-saving infrastructure bonds. There are NO Admin Charges at all. All the 10K you invest, will get invested fully. Assuming a very low interest payment of just 5%, we have the following table for Bonds:


Previous Year Carryforward (a)

This Years investment (b)

Total Investment (a+b)

Return

Total Return

Year 1

-

10,000.00

10,000.00

5%

10,500.00

Year 2

10,500.00

10,000.00

20,500.00

5%

21,525.00

Year 3

21,525.00

10,000.00

31,525.00

5%

33,101.25

So at the end of 3 years, I will have a total of 33101 + 9K (tax benefit) = 42101.00 Rs. Over my invested value of 30K, I made 12,101 Rs. Simple average for 3 years gives me 12101/3 = 4034 = 40.35% of returns each year. Compare this 40.35% to the returns generated by ICICI Prulife policy (27.18%) it is way better than the Pension Policy.

Now, the question is of returns. So lets increase the returns to 20% for the policy. We get the following table:


Previous Year Carryforward (a)

This Years investment (b)

Total Investment (a+b)

Return

Total Return

Year 1

-

8,200.00

8,200.00

20%

9,840.00

Year 2

9,840.00

9,000.00

18,840.00

20%

22,608.00

Year 3

22,608.00

9,275.00

31,883.00

20%

38,259.60

Total: 38259 + 9K = 47,259.

Total returns = 17259.

Simple yearly average: 17259/3 = 5753 = 57.53%

This is the BEST case scenario, where the return generated by the Professional Managers is supposed to be consistent at 20% each year. This case performs better than the bonds. However, the market does not work in this way. No body can consistently guarantee sure shot returns, as I’ve explained in my previous articles. How about the risk that you have taken for this policy as compared to the RISK FREE BOND investment? Is it really worth taking a risk into uncertain future, especially when the managers are pocketing a hefty fee for managing your money?

Are they really guaranteeing even a 4% return (equivalent to their minimum commission)? OR even the guarantee of principle protection?

Also, your bonds will mature in 3 years time – for sure. You invest in 1st year and then decide not to invest in 2nd year – that is possible in bonds. It is NOT possible in the policy, atleast for the 1st 3 years you will have to keep investing.

Some of my friends have invested as high as 50K each year. All they ended up with was the tax-saving policy, with a commitment to invest 50K each year, for the 1st 3 years.

I have nothing against the ICICI Prulife policy makers, or any other organization offering such policies. I am attempting to highlight the problems and highly uncertain returns (even losses) from these investments for tax-savings (especially as compared to the Risk free bond investments offering similar tax benefits).

Interestingly, despite so much long term commitment required from the customer’s side, the financial organization does not offer any guarantee for returns. For people (like me) who have bought ICICI PruLife policies, I’ll suggest them to have a look at the policy statement (either online or in paper form). It will have a section for “SUM ASSURED” – basically indicating the sum assured at maturity – i.e. after 25 years or when the person decides to terminate the policy. Here is the screenshot of my online statement:



In my policy, the SUM ASSURED is showing as ZERO. They are taking 18%, 10%, 7.5% and 4% charges from me, still all I’m assured is ZERO. Go to the homepage of ICICI Pru Life (www.iciciprulife.com). The logo carries the punch-line: “We cover you, at every step in life”. My policy may run for 25 years, they assure ZERO amount on maturity and “Claim to Cover me, at every step in my life” . On the same homepage, in the bottom right corner, you’ll see an animation that carries the following words: “Education guaranteed, Retirement guaranteed, Future guaranteed” . The latest TV ad has he punch-line “Jeetey Raho” – Keep Living. The best way I can describe this is “Keep Living (under the false assumptions of making good returns), and Keep Paying ADMIN FEE to the PROFESSIONAL MONEY MANAGERS” .

Another interesting part is that I have recently sent them a mail, asking them why this sum assured showing as zero despite my policy running for so many years. Usually for all other queries, I’ll receive a response within 2 business days. However, for this particular query, all I’ve received is an automated mail, mentioning that my question has been received. Despite 2 reminders, I’ve not received any response. Fortunately, the automated response also had a call no. assigned to my request, so atleast I have a proof in my mailbox that they have not responded to a valid question.

I’m sure individuals would have had similar experiences with other policies from other organizations. I’m not against these organizations or their policies – it’s a business, they have to do it, they have to pay to agents, fund managers, advertisements, etc. It’s the uneducated and unaware investors like me who are responsible for our investment decisions. If instead of buying this policy, had I bought ETFs on Sensex, I would have been much-much better off. The policy states: Investments are subject to Market risk. I believe its better to take market risk on my own on the entire market, instead of paying such a heavy commission to someone else without any guarantee. If I am risk averse investor, then tax-saving bonds would have been a better option –atleast sure shot fixed interest would have been guaranteed.

Now comes the question, how about the tax-savings??? If you have to invest for long term, better invest in bonds year after year. The best part it you can discontinue it whenever you like. You don’t have to commit a certain sum each year, if you want to continue your investment – You can invest the amount you wish. OR take PPF account – Prulife policy is for 25 years, PPF is for 15 years, that too with a fixed interest rate of 8.5%, so no risk, yet guaranteed returns. Also, no one is going to ask you for the source of income and the interest in PPF is not taxable. Want some more better return from stock market in the long run, go for ETF’s or IF’s. Long term capital gains tax is Zero. You will win on all the fronts, provided markets go up in the long run. You may not be able to save tax on ETF’s and IF’s, but is you really wanna benefit from the stock market, their returns in long run will be much better than what you save in taxes.

So what’s the point in paying commission to others?

Part II on the same to continue

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20 Comments: Post your Comments

Karun Bir Singh Sandha said...(on 5 July 2007 at 23:52 )  

Hi Shobhit,

I am of opinion that instead of Tax saving bonds which give 5% returns you could have taken example of PPF/PF which give returns of 8% and 8.5% resp.

Karun Sandha

M O H A N said...(on 6 July 2007 at 02:55 )  

Your blog is worth its value in Gold. The behaviour explained can be seen in any office.

I hate these agents who perpetually cheat. Govt should ban mixing risk with investment in terms of insurance and investment are seperate entities but who knows is the question.

cheers
mohan!

Anonymous said...(on 6 July 2007 at 04:48 )  

excellent one ..shobit- u hit the nail on the head

Suresh said...(on 10 July 2007 at 23:36 )  

Hi Shobbit, Thanks very much for the candid evaluation of the hyped up policies. I had called my insurance agent to sign up a policy this afternoon. I think i'll ask him to hold on !!!!. Tnx again. Grateful if you could throw light on avenues for purely risk coverage even w/o tax breaks and about mediclaim polices. I read premiums on mediclaim policies by National Insurance are going to be revised upwards.

Anonymous said...(on 11 July 2007 at 19:38 )  

Hello Sir,
Please add me email id to your list.

amitg.borkar@gmail.com.

Thank you throwing light on all these issues...

Anonymous said...(on 12 July 2007 at 01:19 )  

Well am excited but confused too. my view on this is why dont we leave these kind of policies on a long term, since admin fee is eventually getting decreased. At certain stage it would be negligible or might be nil(This is ofocurse very rare). Could we come to this conclusion? Reason is i already left some part of my money to manage PROFESSIONALY huh!:(
Sridevi samy.

Bhupesh said...(on 13 July 2007 at 05:01 )  

I did bought pension policy from ICICI, thanks to my little knowledge that time and FM who thought they are doing good to people to say invest 10k in pension plan to avail tax break.

From last 6 month I am thinking of asking ICICI what will be surrender value of my policy (I believe it will be quit less compared to sum deposited - commissions/charges) and then evaluate if it is good to continue or not.

Mahen said...(on 13 July 2007 at 05:22 )  

All you said is very true. The salaried class, which is generally very busy in doing its core work and does not read up much or spend enough time understanding the various policies are the ones who these agents target the most. Many people learn about the real stuff only after one or two bad experience. I too had taken an insurance policy in which sum assured was exactly equal to what i would have paid as premium during the whole span of 25 years. While selling the policy to you, they will make all tall claims but when the policy document comes home you come face to face with reality. I can celled the insurance policy within 2 months, but lost 1000 rs in the process.

Aniruddha said...(on 13 July 2007 at 22:49 )  

Please Help Me
Hi Shobhit
Today i came across your blogs and it opened my eyes..also enlightened me about investing.
Here i am seeking your professional advice.

I have taken 2 policies, one from Sunlife & another from Aviva. both have yearly premium of 25k. uptill now i have paid 6 qtrly premiums of 6250 in both.
apart from that as you mentioned in your article, i have blindly taken pension plan from HDFC, premium 20k yearly for 22 yrs. towards that i have paid 3 qtrly premiums of 5k.

After reading your articles, i wish to surrender my HDFC pension plan, although i wouldn't be getting any money back, i am ready to give up those 15k paid as premiums. What is your say ? also i think i can't do anything for those 2 policies but pay regularly.

I am short-medium term trader/investor and currently holding 240k portfolio of 35 equities. with 21k unrealised profit.in one month (i shuffled my entire portfolio on Sensex 14200 month ago). Out of this 240k i actually contributed 175k & rest came from regular profit booking and ploughing back. I have started trading/investing in Nov 2005. Currently i am holding 6 scrips in which i can see min 20% profit in 1 month, and couple of scrips showing 40%+. Since i read various articles on internet about investing & long term gains, i am bit hesitant to book profits. please throw some light on what would be one's strategy for investing. 1) Buy & forget? 2) Book regular profits? 3) Day trading? (this is not investing). what should be the ideal shuffling intervals.

I have taken housing loan for which i am paying monthly 16k as installment. i wish to build such a strong portfolio that would fetch me my entire home loan in 20 yrs. i believe every Rs 100 paid as prepayment of home loan means losing an investment opportunity. i would rather put that 100 Rs in mkt for better results.
What is your comments on this ? is this possible ?

Please add me aniruddhakul@gmail.com in your mailing list.

Thanks & Regards

Investment n Trading Advisor said...(on 15 July 2007 at 21:37 )  

Aniruddha,

First of all, dont blindly surrender your policy. Even if you are a very wealthy man, it does not make sense to forego 15K :-).
Contact HDFC, and ask them about conditions of withdrawal. May be that you'll have to wait for 3 years till you can withdraw your policy - better wait for that time instead of booking losses by foregoing the policy.
Second, PLEASE DO NOT BASE YOUR FINANCIAL JUDGMENTS on anyone's blog or advice. Take your own decisions. My articles may look good, but market works in their own ways - and I may be proven completely WRONG. THat's what I advocate in all my articles, Things work RANDOMLY, so take your own decision and be responsible for it. I will tell you what's good and bad within a product - you'll have to decide what to do. Dont chrun your portfolio on anyone's advice.

Thirdly, do not expect any sure shot money making venture in the market. Dont think that by investing in the market, you are sure to make profit to pay for your home loans.
Fourth, the best way to invest is to pre-pay your loans. When you pre-pay your loans, it automatically saves you a MINIMUM of 10% interest rate (that too compounded). So the best way to invest is to get rid of your loans first, before jumping in the market.

However, I just want to tell you one thing: What's the point in investing so much in the high commission policies, when you are already laden with the home loan commitment? Please repay that first, and then invest.

Anonymous said...(on 17 July 2007 at 00:17 )  

hi shobit,
thanks a lot for this article.

What is ETF or IF which you have mentioned in the article?

regards,
Aravind

Andy K said...(on 23 July 2007 at 07:20 )  

Thanks Shobhit
I got your points right.

Regards
Aniruddha

Rashu said...(on 12 August 2007 at 22:14 )  

Hi Shobit,

Can you please throw your views on MetLife's TROP insurance policy ? I found this policy to be partly term and partly endowment.

Thanks,
Rashu

Anonymous said...(on 17 October 2007 at 11:11 )  

Hi Shobit,
it was nice reading your article, but i think you are partly right. I am also a reglar investor and have insurance policies from few companies. The wrong thing which many of us do is that we dont read the terms & conditions for the said plan/scheme. I would also like to tell you that you had opted for a pension plan & not an insurance plan, thats the reason it shows sum assured = zero. sum assured means the insurance cover a person gets in a policy. The basic thing is everyone of us does work for earning so does the agent of any company whether its insurance, mutual funds, fd's, bonds or any of the jobs.

Regards,
Amandeep Singh.
aman_s@hotmail.com

ravi said...(on 23 November 2007 at 07:24 )  

HI SIR
IT IS EXCELLNET TO READ THIS EYEOPENIG CONCEPT OF THIS SO CALLED MNC FUND WHICH IN ACTUAL MEAN THEY MAKING FOOL TO UNWARE INVESTRO LIKE US
I FEEL THAT I M FORTUNATE TO READ THIS ARTICLE
THANK YOU SIR FOR VALUABEL SUPPORT AWARE INVESTOR LIKE US
RAVI
KINDLY SEND ON ravihirani@rediffmail.com

Anonymous said...(on 20 February 2008 at 09:42 )  

Hi,

This is a wonderful stuff to read and get knowledge. Pls add my eID and send your latest updates pls..
ma_mba@yahoo.de

Thanks again.

Bhupesh said...(on 26 February 2008 at 23:29 )  

I think calculation should have been like ..

"So at the end of 3 years, I will have a total of 33101Rs. Over my invested value of 30K - 9K (tax benefit)= 21K , I made 12,101 Rs. Simple average for 3 years gives me 12101/3 = 4034 = (??) % of returns each year. "

As investor is getting 3k saving upfront, so invested amount is actually 7k not 10k.

Sachin S said...(on 10 December 2008 at 02:57 )  

Hi,
Very helpful article to read before investment. Kindly Add my mail id in your list for latest update and if possible mail me link of all post from you.
sachin.satawkar@gmail.com

Sachin said...(on 8 January 2009 at 05:08 )  

Hi Shobhit,

It's very informative article. I would like to get the alerts of new articles.

Please add me in your mailing list.

sachin.bhosale@live.com

Thanks!

Sachin

manoj said...(on 9 January 2009 at 03:55 )  

Hi Shobhit,

I have read your message to public on investment and tax saving and would like to have more informations, which may please be forwaded to me on "manojkesavan30@gmail.com"

Wish you all happy and fruitful trading and investing activities with safety! = = = Post a Comment

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