Term policies are the cheapest way to seek financial security for your near and dear ones. In case of an unfortunate event, the family members get a lump sum to take care of their expenses.
There are many policy payment options offered by insurers for its term plans. In addition to the regular premium, there are limited premium plans whereby you pay a higher premium for fewer years, while the cover continues for a longer period.
For instance, take the case of a 35-year (non-smoking) individual who seeks a Rs 1 crore term cover until he turns 60 years of age. Under the regular option, he would pay an annual premium of Rs 12,208 for the next 25 years.
However, if he goes for the limited payment period of 10 years, his premium increases to Rs 25,173 and further to Rs 45,267 if it is for five years. However, in both cases, the life cover continues till he turns 60.
Short and steep
Often, insurers advertise how you could save 12-26% of your premium by going for a limited option. This is calculated by looking at absolute differences in the total premium payments as compared to that of a regular premium plan.
For instance, total premium works out to Rs 3.05 lakh under regular option, while it is Rs 2.26 lakh for a five-year paying tenure – a saving of Rs 78,865 (26% saving that is). Similarly, savings are 14%, 18% and 12% for payment tenures of seven years, 10 years and 20 years respectively (see table).
However, such calculations ignore the opportunity cost of shelling extra money for buying limited premium plans. What if it could have been invested instead in equities earning a conservative 10 per cent per annum for you?
If you opt for a five-year premium, the opportunity cost works out to Rs 6.6 lakh and is even higher for seven years at Rs 7.9 lakh. It is relatively lower at Rs 4.8 lakh and Rs 38,000 for 10 and 20-year premium options respectively. Usually, the shorter the duration of payment, higher is the opportunity cost. These calculations are based on actual quotes of a leading insurer and can vary marginally between insurers.
Should you buy it?
Limited premium options still might be opted by those who don’t want any financial liability to extend beyond their earning years. Self-employed and businessmen whose incomes are lumpy can consider it.
Since the premiums are paid earlier, the chances of policy lapsing also reduce.
The policyholder of a limited premium term plan is also entitled to a surrender value if it is surrendered before maturity. The amount one gets depends on the years in the policy and subject to company rules. In contrast, the regular plan doesn’t have any surrender value.
In case of investing, it makes sense to invest more and in the earlier years to leverage the benefits of the power of compounding. However, term insurance is a pure risk cover and paying higher premiums for the same cover doesn’t have any real benefit.
Limited premium term plans might apparently look cheaper but actually entail a high opportunity cost. At best, you can use it to limit premium payment up to your age of retirement and by making marginal modifications. Otherwise, focus solely on regular premiums while buying term plans.