Introduction:
Amol was convinced that buying a Term Plan with a premium payment term till 100 years does not make sense. A week went by and Amol was finally ready to buy the term plan over the weekend. So early Saturday morning sat in front of his laptop and started browsing through the website of the life insurer he had finalized to purchase a term plan for himself.
After filling in his personal details Amol went to the payment page and was about to select the premium payment term as annual when he was distracted by a message on his laptop screen that instead of annual premium he can pay a single premium and he could get the same cover. The premium amount for a single premium payment was a much higher amount than the annual premium payment amount for an obvious reason.
As Amol already exhausted his Sec 80C deduction through his share of EPF contribution there was no tax benefit to be realized by paying a single premium but he wanted to understand whether he can gain something out of paying single premium for this term policy by paying for it for one year only and then afterward the cover will continue till 65 years of age, the age at which Amol is planning to retire.
Also, Amol was in a corporate job with long term prospect and not a person (such as actor or sportsperson) whose income stream is available for only a few years so buying term insurance with the intent of getting coverage for a considerable period of time by paying a single premium is not the case with Amol.
Consulting with Sahaj Money
So he picked up the phone and called up Sahaj, a fee-only financial planner, on a lazy Saturday morning to pick his brain about different premium payment terms. Few rings went by but Jose didn’t answer the call and Amol was almost about to drop the call when Sahaj picked the call.
Jose asked Amol if everything is all right, to which Amol said he just wanted to discuss the premium payment for the term plan he is planning to buy. Sahaj told Amol to message him the details and he will get back to Amol by evening.
After a few hours, Sahaj sat in front of his laptop and started comparing the merit of buying a term plan with single versus regular annual premium payment. He looked at the company’s website offering the term plans and downloaded the quote for all of these options.
Doing Maths
The premium quoted by the firm for these options was for a 25-year-old, non-smoker, Male. The premium including GST for 65 years of coverage with single payment was 1,21,245/- rupees and for regular annual premium with 40 years of the annual premium, payment was 5,074/- rupees (with total premium paid over 40 years is 2,01,720/- rupees, a difference of 80,475/- rupees).
By afternoon, Sahaj emailed a spreadsheet with scenario analysis to Amol with the assumption that if Amol were to buy a term plan with coverage till 65 years of age with single versus regular annual premium payment.
Sahaj also assumed that if Amol was to invest the differential amount 1,16,171/- rupees (the difference between single premium of 1,21,245/-and regular annual premium payment) into an investment option (example: debt mutual fund with short term capital gain tax of say an upper bracket of 30%) with even 6% CAGR (Compounded Annual Growth Rate), and then withdraws 5,074 /- rupees per year from the corpus to pay for annual premium.
1,16,171/- rupees invested @ 8% CAGR for 40 years in debt mutual fund (with annual redemption of capital gain for withdrawal of 5,074/- rupees every year subjected to STCG @30% and again reinvested in debt mutual fund @ 8% return- assumed no reinvestment risk)
If Amol invests 1,16,171/- rupees into such a debt mutual fund for 40 years with annual withdrawal of 5,074/- rupees for 40 years to pay for the annual premium payment for term plan the amount of income that Amol can generate by investing the difference between the single and regular annual premium rate would give Amol an additional corpus of nearly 3 lac rupees post-tax basis at 30% tax bracket at the end of 65 years without compromising his life cover.
But over 40 years the value of money would go down due to inflation which slowly but steadily eats into the value of corpus, so in 40 years the value of 3 lac rupees would be worth just 80,000/- rupees in today’s term @ 3.5% inflation (nearly the extra amount which Amol would pay over 40 years if he picks regular premium over single premium but if we were to consider same inflation rate for discounting the amount paid as total annual premium paid over 40 years then the value of 2,01,720/- rupees would also be 1,13,430/- rupees) so effectively a return of just 33,000/- rupees in 40 years. Not a thing to rejoice here but Sahaj just wanted to show Amol that this is what he can choose to do with his money.
As Amol has runway of 40 years to invest the difference so if chose a slightly aggressive investment style to invest a small portion in debt fund (say the amount which could cover 5 years of annual premium payment i.e.; 30,000/- and major portion say 86,000/- in equity fund for 5 years or more.
After 5 years if he moves a portion of money into debt fund to pay for again 5 years of annual premium amount and rest invested in equity fund the eventual returns could be much more. But Sahaj thought to keep things on an even keel that’s a discussion for another day.
Conclusion
Sahaj felt the rational case for not going with a single premium is good enough to convince Amol to go for the regular annual premium. What do you think? Does it make sense to you what Sahaj is trying to tell Amol or is he is missing something by asking Amol not to go ahead with single premium payment for term plan till 65 years of age?
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