Don’t Buy ‘Return of Premium Term Plans’

It is a no brainer that when it comes to life insurance, its best to purchase term insurance policies. By paying a very small premium every year (generally a few thousand rupees), you get a large life insurance cover.

And if you are curious, then know that you can never get the same cover for the same premium if you opt for endowment plans or moneyback plans of LIC. If you have doubts, then read these FAQs on term life insurance.

But inspite of it being clear that term plans are the best, many Indians are still on the lookout for insurances that pay them back something. They just don’t like the idea of not getting anything if they survive the term! Average Indian still expect some return from his life insurance policies.

To cater to such people, insurance companies cleverly launched Return of Premium Term Plans few years back

What is Return of Premium Term Plan?

A simple term plan pays the sum assured in case of death of policyholder during the policy term. In case of survival, nothing is paid out. But a return of premium term plan has an added benefit. In addition to paying sum assured in case of death, it also pays back the money in premiums in case of survival. It is also called a TROP (or Term Insurance with Return of Premium).

So if I were to list down the difference in term plans and return of premium plans, then they will be as follows:

  • In case of death, both simple Term Plan and Return-of-Premium Term Plan pay the same amount.
  • In case of survival (or maturity), simple Term Plan pays nothing. But the Return-of-Premium plan gives back all the premiums you paid over the years.
  • Most importantly, the premium for Return-of-Premium plan is different from that of the simple term plan. How different? We will see shortly.

This might look good to the uninitiated as you get a term plan and you also get back the premiums if you survive. What more could one ask for?

But wait for more.

Suppose you are a 35-year old, non-smoking male in Mumbai, who wants to buy a Term Plan of Rs 1 crore coverage and 25-year tenure.

If you check premiums only for both types, you will find this:

  • Plain Term Plan – Rs 12-13,000 + taxes annually for 25 years
  • Return-of-Premium Term Plan – Rs 32-33,000 + taxes annually for 25 years

The difference in premium isn’t small given the fact that both provide the same Rs 1 crore life cover.

Also, in case of survival the simple term plan will not pay anything while the return of premium plan will return back all the premiums you paid over the past 25 years (i.e. 25 x Rs 32-300 = Rs 8-8.5 lakh).

To summarize, this is what is on offer:

Term Plan vs Return of premium plan

But don’t be in a hurry to judge right now. Let’s go a bit further.

The difference between the premiums of two policies is Rs 20-21,000

So basically in the Return-of-Premium plans, you are paying Rs 20-21,000 extra every year (over simple term plan) for 25 years to eventually get back Rs 8-8.5 lakh. Right?

Looked at differently, the Return-of-Premium Plan charges Rs 32-33,000 every year Now out of this, Rs 12-13,000 is used to provide an insurance cover of Rs 1 crore while the remaining Rs 20-21,000 is invested (by insurance company) annually so that after 25 years, it becomes Rs 8-8.5 lakh.

Now what if instead you chose to buy the simple term plan (with Rs 12-13,000 premium) and used the difference amount of Rs 20-21,000 to invest in PPF (giving 7.1%) every year. How much would you have saved in 25 years?

The answer is Rs 13-14 lakh

That is almost Rs 5-6 lakh more than what you get back from Return-of-Premium plan. And that is when we chose a simple basic PPF giving 7.1% return. Imagine the corpus accumulated if even a part of Rs 20-21,000 was instead invested in better-return giving equity funds.

To give you an idea, 50:50 PPF:Equity Fund would have generated a corpus of Rs 41 lac plus! (assuming 7.1% annual average return from PPF and 11% from Equity Funds). Any guesses what you will get?

Around Rs 19-20 lakhs – which is much higher than what return of premium plan returns back to you.

I have heard stories that agents try to fool the buyers by saying that these return of premium plans are basically ‘free insurance’ as it returns back the premium. But now you have seen what the reality is.

Return of Premium term plans are much more expensive than regular term plans.

A simple term plan is much better as you get the same cover at a much lower premium. The return of premium plan charges twice or thrice a normal term plan. In addition, you can invest the difference amount every year and create a much larger corpus than what is returned by the return-of-premium plans.

So keep things simple. Don’t mix insurance and investment.

Life insurance is very important. In fact, insurance should be purchased before investing. Simply purchase a plain term plan and invest the excess difference amount (over the return-of-premium plan) in PPF and/or equity funds, etc. You will get a much higher amount on maturity than what the Return-of-Premium plans promises to return.

Further Reading:

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