Many of us realize that investments and insurance shouldn’t be mixed. You will get low life cover and poor returns, especially with traditional life insurance plans.
If you are young and make such mistakes, you still have time to make up for such mistakes.
However, if you are retired or closer to your retirement, the hit to your finances will be much bigger. It is not just that your ability to make other investments is low. Your old age plays an important role in bringing down returns.
At an older age, the presence of insurance component in your investment product can compromise returns significantly. That’s what we will try to assess in this post.
Let’s first try to understand if you need life insurance during retirement.
How much life insurance do you need?
Your life insurance cover + Existing Wealth should be enough to:
- Square off all your loans
- Meet all the financial goals
- Provide for regular expenses of the family for a planned period.
This is the equation I rely upon to arrive at life insurance requirement.
Do you need life insurance during retirement?
You should have saved enough for all the aforementioned points by the time you retire. If you haven’t, then you have not done your job well.
If you need life insurance during retirement, then, as crazy as it may sound, you are better off dead than alive (when it comes to your finances). You wouldn’t want to be in such a position, would you?
However, I want to touch upon a different aspect in this post.
Many purchase life insurance plans as investments during their retirement. This is a poor choice. I want to discuss how the element of insurance can compromise returns.
What is the problem with ULIP?
In case of ULIPs, a part of your premium goes towards providing you life cover. Such charges are called mortality charges. Remaining part of your premium gets invested in a fund of your choice.
Mortality charges also increase with age since the chances of death increase with age. That also explains why term insurance premium increases with age. Therefore, if you have purchased a ULIP, an increasing percentage of your premium goes to meet mortality charges (as your grow older). And less goes towards investments.
Insurance companies set off mortality charges by regularly liquidating some of the units from your fund corpus. The greater the mortality charge, more the number of units that need to be redeemed (everything else being same).
For investors in their 60s, 70s or 80s, mortality charges can make a serious dent into your corpus. Not much may be left for investment.
There have been many examples where investors have earned negative returns in such plans. In one case, investment of Rs 50,000 became Rs 248 in 5 years. In another, a senior citizen invested Rs Rs 3.2 lacs over 6 years and got only Rs 11,000 back. These are clear cases of mis-selling. No suitability analysis was done at the time of sale. There are many such examples.
Fortunately, IRDA drafted a few regulations which ensure that you get at least your premiums back. However, that does not ensure that you get good returns.
To be frank, I do not dislike ULIPs as much I dislike Traditional plans. However, we must realize that insurance does not come free of cost. And the cost only increases as you get older.
When you do not NEED insurance, there is no point paying for it. It compromises returns.
By the way, this is not a comparison between ULIPs and a combination of term insurance and mutual funds. If you do not need life insurance, even term insurance is a waste of money.
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What is the problem with traditional plans?
There are many problems but I will limit myself to purchase of insurance during retirement.
In traditional plans, the bifurcation between mortality charges and investment is not as crisp as in ULIPs. However, for the same Sum Assured, the premium increases with age.
For instance, the annual premium for LIC New Jeevan Anand for a 35-year old for Sum Assured of Rs 10 lacs for 15 years is Rs 80,300. The premium for the same coverage for a 50 year old is Rs 92,746.
In traditional plans, the bonuses are linked to the Sum Assured. Since the Sum Assured is same, both will end up with the same maturity amount (if they purchased at the same time) after 15 years.
You can see 50-year old person has paid a much greater annual premium for the same maturity amount. Therefore, his returns will be lower.
In my posts on review of traditional plans, I calculate potential returns for 30-35 year old person. Such returns hardly ever exceed 4-6% p.a. You can see such returns will only go down if you are older.
Fortunately, many of these plans are not available for senior citizens. However, I have not researched the entire domain. There are still quite a few traditional plans that will be available for senior citizens. LIC Single Premium Endowment plan is one such example.
As I have mentioned many times before, I have nothing against LIC. All the private insurance plans come out with traditional plans too. I use examples from LIC because its plans are the most popular among investors.
What about term insurance?
If you do not need life insurance, even term life insurance is a waste of money.
However, the good part with term plans is that you can stop paying premium at any point of time. Since you do not get anything back anyways, you do not incur any penalty on surrender.
Many of us purchase term plans that run well into your retirement. For instance, a 30-year old person purchases life cover for a tenure of 40 years. For a popular term plan, the premium for 30-year cover is Rs 10,523 while the premium for 40 year cover is Rs 13,508.
So, you are paying ~3K more to have the flexibility. As mentioned earlier, if you don’t need it, cancel the plan. Many are fine with this extra cost for the flexibility. Fair enough.
Another good point is that there is no investment angle. So, buyers don’t have fancy expectations from their purchase. Investments for goals go on as usual.
Mis-selling is not just limited to insurance
Many of us attribute such poor returns to insurance agents or bank officials. However, mis-selling is not limited to insurance products. It can happen in pure investment products too.
For instance, a recent MoneyLife article talked about a wealth manager who persuaded an 87-year old man suffering from Parkinson’s disease to invest Rs 1.2 crores (75% of his wealth) in a close-ended mutual fund with 7-year lock-in.
Can you believe this?
Why can’t we have a simple checklist?
Let the intermediaries sell what they want to sell. Purchase is your choice. Therefore, blame does not solely lie with intermediaries. If you purchase useless products, you are to be blamed too.
A simple checklist for investments will really help.
For instance, if you are retired, some of the items in the checklists can be:
- If I do not need insurance, I will not buy any product that has an element of insurance.
- Life Insurance companies can’t sell pure investment products. Therefore, I will not purchase any product from any insurance company.
This will keep you away from toxic insurance products if you do not need life insurance.
In this post, the intent is not to highlight the instances of mis-selling or that mixing insurance with investment is a poor choice. The idea is that you shouldn’t incur cost for something you don’t need.
You must figure out if you need life insurance. If the answer is no, do not pay for life insurance. After all, nothing comes free. Select pure investment products.
If you have planned well, you will not need life insurance during retirement. And if that’s the case, there is no reason to bear such cost of life insurance.
Do note there is no one-size-fits-all solution to investment problems. For instance, annuity plans from insurance companies can play a good role in select cases. However, in most cases, avoid life insurance if you are retired.