It was about this time last year when the Reserve Bank of India reduced the repo rate by 75 bps (basis points) to 4.4% – a historic low – in an attempt to mitigate the economic impact due to the pandemic.
The announcement had a secular impact on most savings schemes with bank fixed deposits (FDs) being impacted the most. Soon after the cut, rates for savings schemes were also reduced.
The rate of interest on bank fixed deposits have been declining, from 8.5% in 2014 to 5.4% in 2020. With the constant drop in rates, these products have now become less attractive among customers looking for products that guarantee returns for a longer time period.
The idea behind any investment is to get a return that will at least beat longevity risk and ensures that real return is guaranteed.
It is important to know that as the economy develops, returns on products offered by the government will continue to drop.
Over the last one year, the life insurance-products category has emerged as the most preferred financial solution owing to its role in securing the family’s financial future.
Concerned about the economic slowdown caused by the pandemic, a majority of the population today believes that it is pivotal to have a long term guaranteed-return plan in the financial portfolio. A big advantage with investing in guaranteed-return products is that the downside of the portfolio would be substantially limited. In case of market volatility when market-linked products underperform, fixed/guaranteed-return products continue to give the same return. With such products, you can lock in the rate of interest being offered for a maximum of 45 years.
Most people purchase guaranteed-return products — also known as savings-plus protection plans offered by insurance companies — with an objective of availing protection and building wealth for the future. However, often customers have to liquidate the investments made for the long-term goal for unexpected exigencies such as financial hardships due to health emergencies.
This process of terminating insurance-cum-savings plans before maturity is termed as surrender. Most investment instruments available in the market do not allow you to liquidate savings during the mandatory lock-in period while those that allow you to surrender your policy levy a hefty surrender charge.
To tackle this drawback of savings-plus protection plans, insurers have come up with, or will soon introduce, a new variant of guaranteed-return plans under which you can easily surrender your policy in case of financial emergency within the first five years, without paying any surrender charges. The customers get back 100% of the invested capital without any deductions.
Guaranteed-return plans come with triple-taxation benefit. There is no tax on the amount invested, accruals (the amount that grows) and the maturity amount. However, bank FDs lack such features.
For instance, Rajeev Nigam, earning ₹20 lakh per annum, decides to buy an existing guaranteed-return plan by investing ₹10 lakh as a lump sum. On this, he will save ₹46,800 in tax benefit. Further, on maturity, Mr. Nigam would receive ₹40.4 lakh that would be completely tax-free.
Had Mr. Nigam invested the same amount in a bank FD, though his invested amount would have been tax-free, he would have had to pay tax on the maturity amount as income from FD is not tax-free.
On the maturity amount, Mr. Nigam would need to pay ₹9.11 lakh in tax — as he would fall under the 30% tax bracket.
By investing in the product, Mr. Nigam would save a total of ₹9.58 lakh. Guaranteed-return products offer promising IRR — the annual rate of growth the investment may generate – ranging between 5.3% and 5.8%.
Often an unfortunate event such as the sudden demise of the breadwinner of the family proves disturbing for financial dependents in more ways than one. To address such situations, guaranteed-return plans are a composite solution.
They assure long-term, guaranteed income along with security against unforeseen financial emergencies.
Customers investing in such plans even get a life cover equal to 10 times the annual premium. Hence, these plans attract the attention of even those customers who traditionally invest in FDs.
(The writer is Head of Investments, Policybazaar.com)