It is in school that we are taught the basic difference between simple and compound interest. We are taught the fundamental principle that it is always the compound and not the simple interest that is the effective rate of return on any investment.
However, it increasingly seems to me that this is a lesson that is either not
learnt well or is forgotten way too early. Otherwise, nothing else explains
investors falling over each other to invest in what essentially is a fixed deposit
that, depending upon the age of the investor, offers 7.32% p.a. at best and
4.32% p.a. at worst. Yes, I am talking of LIC's Jeevan Aastha, a policy that
seems to have taken the investor community by storm.
However, this simple FD like structure gets complicated on account of the investment being combined with insurance and the usage of differing terminologies such as basic sum assured, maturity sum assured, guaranteed additions, loyalty additions, death benefit, maturity benefit and so on. Therefore, this week's article analyses Jeevan Aastha and tries to simplify it for the ready understanding of the common investor.
Let's first take the case where the investor remains healthy, alive and kicking
throughout the term of the plan (5 or 10 years as the case may be). The interest
or return on investment as mentioned by LIC is Rs. 100 per thousand of Maturity
Sum Assured (MSA) per year for a policy of 10 years and Rs. 90 per thousand
MSA per year for a policy of 5 years term where the MSA is one sixth of the
Basic Sum Assured (BSA). Before understanding the above in terms of an example,
please note the significance of the words -- Rs. 100 per thousand per year.
Rs. 100 per thousand translates into Rs. 10 per hundred or 10% per year.
Many unethical, unscrupulous agents are taking this rate of 10% per year and selling Jeevan Aastha as a product that offers 10% p.a tax-free return. And in the current mood of risk aversion, no wonder the public is lapping it up. However, note that the 10% is flat per year on a simple basis. Which means that there is no interest on interest element (which by the way is the definition of compound interest). Instead the investor gets a flat 10% every year.
In terms of an example, a 30 year old investor who invests Rs. 24,810 will receive Rs. 50,000 upon maturity at the end of 10 years translating into a return of 7.26%. The accompanying table lists the age wise maximum and minimum potential return on this plan.
|13 Yr Old||60 Yr Old|
Though there is a mention of loyalty addition, the same is variable and not guaranteed and hence not included in the computations. Generally, the same is around 5% over the term of the plan and hence will not materially alter the returns.
Coming to the insurance element, most investors are being led to believe that
the insurance amount is six times the premium amount through out the term. First
of all, the insurance amount is six times the Maturity Sum Assured plus guaranteed
additions (9% or 10% as the case may be). However, this is only for the first
year. From the second year onwards till maturity, the death benefit drastically
falls to one-third of the above.
Tax treatment of portfolio management schemes
Though it is generally believed that insurance policy proceeds are free of tax, as per Sec. 10(10D), if the premium payable on any insurance plan exceeds 20% of the sum assured, the proceeds cease to be exempt and instead will be fully taxable. In the case of Jeevan Aastha, the single premium will always in all cases be more than 20% of the maturity proceeds Would this not make the maturity amount from the plan fully taxable? A clarification from LIC would be helpful.
Jeevan Aastha is a fixed return investment plan that would offer a return in the range of 6.75% to 7.25% p.a in most cases. Any investment in this plan should be made with a clear understanding and recognition of this return. Note that in terms of the example used in the article, an investment of Rs. 24,810 would grow to Rs. 53,562 if invested in PPF. However, one can invest only Rs. 70,000 in PPF per year whereas there is no upper limit in the case of Jeevan Aastha.
In the case of Nabard's Bhavishya Nirman Bonds, Rs. 8,500 grow to Rs. 20,000
in 10 years, yielding an after tax return of 8.29% p.a. While it is true that
Jeevan Aastha offers insurance along with investment, regular readers of my
column would know that I am not a fan of combining insurance and investment.
You should always buy a term plan, which is the most economical insurance that
you can purchase and then try and optimize your investment returns.
The authors may be contacted at firstname.lastname@example.org