Child plan in Insurance – trap or blessing ?

It was a beautiful day, it was the day when Rishab Singh got the news that he and his wife became a proud parent of an angelic girl child. Rishab was happy beyond bounds and distributed sweets to one and all he met that day. One of them Aarush, who he met that day was a friend of a family friend, was an agent of a Life Insurance company. He shared Rishab’s exuberance and handed over his visiting card to him.

A week went by with Rishab and his wife Tara Singh busy with tending to baby girl needs when Rishab’s phone rang. After picking the phone Rishab realized it was Aarush who was calling to see if he could seek time with Rishab and his family. Although the Singh family were busy they called over Aarush to their place. Aarush came to meet and over the course asked the couple how they are planning to secure the life of a baby girl as now they have added the responsibility of raising a child and secure her future with the money required for her marriage or for her higher education.

As the couple was clueless about same Aarush told them about a “savings cum insurance plan” or in other words an endowment which could help the couple achieve future security of child with sum assured as survival benefit at the end of maturity period (till the child attains age of 18 years) along with insurance cover during the term of the policy and put a cherry on the plan provides an additional tax saving benefit. This was too good to be true an offer and the couple readily wrote a cheque to the company offering the plan along with the filled up application form. Is this a case of a family friend offering free financial advice to a family in need or was it a case of an unscrupulous insurance agent preying on the gullible customer? To help you assess the same let’s dig deep and then perhaps in the end you could make a decision for yourself.

Let’s deal with Insurance 101 to understand why one would need a life insurance plan? An insurance plan is primarily required to protect a source of income as an impairment of this source due to loss of life would result in financial difficulties for the dependents as their expenses and investment required to achieve future goals would be impacted. In layman terms that income source is a family member or members on whose income the family depends to run its expenses and saving for future requirements.

The child in the case of Rishab’s family is not an income-generating member so does she need life insurance cover? So instead of buying an endowment policy for her aren’t Singh family better off instead by investing the annual premium amount in either long-term mutual fund or to keep it simple even a term deposit with any scheduled banks? To get a better grip on the issue on hand to let us look at the enclosed table illustrates a comparison between the existing endowment plan and an option to invest in equity mutual fund.

(in INR)
Year 1Year 2……Year 15Year 16Year 17After-tax

Endowment Plan45,000/-90,000/-……6,75,000/-7,20,000/-7,65,000/-10,00,000/-Nil

Mutual Fund (Equity)50,400/-1,06,848/-……18,28,498/- 20,47,917/-22,93,667/-20,74,301/-10% LTCG Tax on Capital Gains above INR 1 Lac
Term Deposit0/-0/-……46,800 /-94,910 /-1,44,368/-1,41,558/-30% Personal Income Tax on Interest Income
Total50,400/-1,06,848/-……18,75,298/-21,42,828/-24,38,035/- 22,15,858/--

The above comparative calculation is based on premise that a non-income generating family member does not require life insurance and that the parents are not dependent on a child’s income in the future till she attains adulthood at which point the existing endowment policy would mature. Rishab as a sponsor of the insurance policy is paying an annual premium to the tune of nearly INR 45,000/- and this payment would continue for 17 years. On the back of the envelope calculation itself, the Singh family would pay ~ INR 7.7 Lacs as a premium over the term of policy for a sum assured of INR 10 Lacs.

Further, the Singh family requirement is primarily trying to secure the child’s long-term future, hence we are assuming an asset that could fulfill the family long-term goal would be apt for this purpose. One of the assets which meet these criteria apart from other asset class is equity and a long-term average return on equity investment in India comes around 12% on a conservative estimate. To keep things on an equal keel let’s assume that Singh family invests in the ELSS (Equity Linked Savings Scheme) Plan, as just like the endowment plan ELSS too offers tax benefits under Sec 80C of Income Tax Laws on the invested amount. Even with Long Term Capital Gains (LTCG) beyond capital gains of INR 1 Lac putting money in an ELSS Plan till Year 15 (as ELSS have lock-in period of 3 Years) and for rest 3 years Singh’s can invest INR 45,000/- in Term or Fixed Deposits with expected pre-tax return of around 4%. Option B would probably win hands down (based on past returns from equity investments) as compared to putting the same money in existing Option A by a factor of nearly 2 to 1 on a post-tax return basis.

Although the expected event is still 18 years away so we are still speaking hypothetical returns on invested money I hope you got what we are trying to tell you – separate insurance from investment especially when the outlook is long term. Tell us your views about the same at: abhishek.kumar13@alumni.iimb.ac.in

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