Ch. 12: Endowment Plans - How do these work?

Imagine you want to buy a high-quality washing machine. You visit the nearby shop, and the shopkeeper shows you all the latest models. As you narrow down your choices, you decide on a front loader that seems to meet your needs and budget. Before you lock in your money to buy the washing machine, you ask him to explain its working mechanism so that you do not encounter any kind of trouble later on.

The same rule applies to endowment plans as well. Before investing in an endowment plan, you need to understand how it works - to avoid any sort of hassles down the line.

In the previous article, we discussed the entire claim process of an endowment plan. This article will highlight how this plan works in detail.

Let's take a look!

Understand your needs

Before purchasing an insurance policy, it is crucial to figure out your financial goals.
Make sure you estimate the amount of money you and your family will need for both short term goals and long-term goals. This can be buying property, your spouse's higher education, child's wedding, any loans or liabilities, etc. Take into account every aspect of your finances, including your assets and any existing insurance plan you may own.

After determining the amount, you must factor in inflation of 6-8% over this amount for at least 12-15 years. This is to ensure that you won’t end up underfunded when you need it.

You should also calculate and know the Internal Rate of Return of your investment so you can gauge whether it covers your goals. A financial advisor will help you with this, and there are online calculators available as well.

Before buying an endowment plan, you need to determine how much you can invest over the minimum payment period. You need to decide on the premium you're comfortable to pay from your end, based on your budget. Your future needs should not compromise your present circumstances. Ensure that you strike the right balance.

For example, Lalit buys an endowment plan with a premium payment term of 20 years. He should determine the amount he can comfortably invest over those 20 years.

To keep an endowment plan active throughout its policy tenure, you need to pay the stipulated premiums within the due date.

Two important things to keep in mind -

• You will have to pay the prescribed premiums on time for a specified period of time.
• Your funds will be locked in for a long period of time. This means that you or your nominee shall receive the sum assured only on policy maturity or in case you pass away.

So, by investing in an endowment, you're binding yourself to a financial commitment. Please note that you may not be able to withdraw the money from your accumulated fund without suffering significant losses.

Participating Insurance offers a variable bonus in addition to the benefits paid, whether paid as a maturity benefit or as a death benefit. The bonus accrues from the profits the company makes from investing in bonds, securities, debt and equity instruments.

On the other hand, Non-Participating Insurance offers fixed benefits, i.e., the payout given to you when the policy matures or to the nominee as a death benefit is guaranteed.

Both types have benefits and drawbacks. You might decide to opt for a Participating policy if you wish to receive the bonus. In contrast, if you are looking for only guaranteed returns, then a Non-Participating policy is the way to go. Please note that bonuses aren't guaranteed, and they may vary depending on the product and the insurance company.

1. Limited Pay Option

The Limited Pay option may suit you if you can't pay your Endowment Plan premiums until the end of the policy period. It is possible to pay off all your insurance premiums early by making larger payments. However, you can be assured that you will be covered until the end of the policy period.

There are several payment terms you can choose from, such as 10 years, 20 years, 30 years, etc. You can pay your premiums during the payment term that works for you and get the burden off your shoulders.

For instance, Raj, a 35-year-old, is planning to buy an Endowment Plan for a duration of 30 years. He shall retire when he turns 55, and he intends to pay off his premiums liabilities by the time he retires. He chooses the limited pay option and sets his premium payment term to be 15 years. So, by the time he reaches 50, his premium payment shall get over, and he can enjoy the policy benefits for the rest of the policy tenure.

It is possible to adjust the frequency of premium payments with Endowment Plans, based on your comfort. You can choose to pay the policy premiums -

• Annually
• Semi-annually
• Quarterly
• Monthly

In any case, you need to set up an automatic withdrawal or standing order on your bank account regardless of the payment frequency you choose. By doing this, your premiums can be paid on time, and your policy will not lapse.

The joint life option is available during the policy purchase process. By selecting this option, you and your spouse will jointly own the policy, i.e., the both of you will be covered under the same endowment plan. You will be the primary life insured, and your spouse will be the secondary life insured. Your spouse is entitled to receive 20% of your sum assured.

For example, let's say Rajesh buys an Endowment plan with a sum assured of Rs. 60 lakhs. He chooses the Joint Life Option while buying the plan. His wife, Payal, will now become the secondary life insured. So, a sum assured of Rs. 12 Lakhs (20% of 60 lakhs) will be applicable for Payal, his spouse.

Riders are additional benefits you can add to your existing policy at a certain extra cost. They do not require additional documentation or health tests besides those already done for your base Endowment Plan.

Here are some common types of riders available with an Endowment Policy -

• Critical Illness Rider
• Accidental Disability Rider
• Accidental Death Benefit Rider
• Hospital Cash Rider
• Surgical Care Rider
• Waiver Of Premium On Critical Illness Rider
• Waiver Of Premium On Accidental Disability Rider

Please note that this is an indicative list. The riders may differ across products and insurers.

Premiums must be paid on time every year to keep the policy active. The insurance company shall decide the premium based on various factors -

• Policy type
• Cover amount
• Riders opted
• The premium paying option (limited pay or regular pay), etc.

Some products may also give you the option of choosing the premium amount. The sum assured will then be calculated accordingly.

You need to pay the premiums on time every year to keep the policy active. If you fail to renew your policy, it may lapse. If a policy lapses, you may lose out on your benefits. You can set a reminder on your calendar to remind you to pay your premium when it is due. Ensure you put your standing instruction on your bank account, and not a credit or debit card. Credit/debit cards have an expiry date, which can cause your payment to fail.

1. Maturity Benefit

The maturity benefit is a guaranteed return that you shall receive if you survive the policy period. You can receive this amount in a lump sum. In case you opt for a participating endowment plan, you shall also receive the accumulated bonuses along with the maturity benefit.

Depending on the product, the maturity benefit can be -

• Fixed Sum Assured chosen by you -
  You can choose the sum assured based on your financial needs.
• Total premiums paid -
  The sum assured shall be total premiums paid by you. When buying the policy, you have the option to choose the premium that is convenient for you.
  
  Here, the sum assured can be either -
  
  • The total premiums payable under the policy excluding any extra premium, rider premium, taxes, etc.
  • A certain percentage of the total premiums paid, excluding extra underwriting premiums, rider premiums, loadings for modal premiums, and taxes. Depending on the age at which you buy a policy, the minimum and maximum percentages can range from 100% to 400%, or 90% to 150%, etc.

For example -

In 2022, Neeraj buys a Participating Endowment Plan for a policy duration of 25 years. He chooses the sum assured to be Rs 45 Lakhs. The premium for his policy comes around Rs 1,50,000 per year. He has to pay the premiums for the next 20 years.

If Neeraj survives the policy period, he is entitled to receive Rs 45 lakhs as a maturity benefit along with any accrued bonuses in 2046.

The death benefit is the sum assured paid to your nominee if you pass away during the policy term. The death benefit will allow them to live a comfortable life and achieve their goals even in your absence. Once the death benefit has been paid out, the policy will terminate.

The death benefit can be the chosen sum assured or a multiple of the chosen annual premium depending on the product. The nominee can choose to receive the death benefit as a lump sum or as periodic instalments. Depending on the product, the percentage, duration, and frequency can vary.

Let's recall Neeraj's example again.

If Neeraj passes away during the 12th policy year, his nominee will be entitled to Rs 40 lakhs along with any accrued bonuses. His nominee can choose to receive the death benefit as a Lump Sum or Periodic Instalments.

As a Lump Sum

As Periodic Instalments

Let's assume that his nominee chooses to receive 25% of the death benefit annually over a span of 4 years.

Thus, the nominee shall receive Rs 11,25,000 annually from 2033 to 2036.

There may be several reasons because of which you may want to discontinue your policy. You may face financial difficulties, or you may find a plan with better benefits and so on. This discontinuance is known as Surrender of the policy. In such a situation, you will receive a surrender value. You need to pay all the due premiums for at least 2 years for the policy to gain a surrender value.

In 2022, Mahat buys a Participating Endowment Plan with a 35-year policy term and a Rs 40 lakh sum assured. The annual premium amounts to Rs 1,50,000, to be paid over a 25-year period. He appoints his wife, Manasa as his nominee. His policy does not include loyalty or guaranteed additions. Also, he also did not choose the joint-life option.

Let's see the benefits payable under his policy.

• If Mahat survives the policy period
  Let's assume that the maturity benefit is the sum assured along with any bonuses. Mahat will receive it once the policy term gets over.
  So, Mahat is entitled to receive Rs 40 Lakhs as the maturity benefit in 2056, along with the accrued bonuses.


• If Mahat passes away in the 10th policy year -
  His wife, Manasa, is eligible to receive the death benefit. This is the sum assured, along with accrued bonuses.
  Therefore, his wife will receive a death benefit of Rs 40 Lakhs along with the accrued bonuses in 2031. The policy will terminate once the death benefit is paid out to her.

If you are looking for a way to set aside some funds to secure your future, then you can opt for an endowment plan. Now that you know how it works, there are a few crucial things that you should keep in mind before investing in one. This will be discussed in the following article.