Look before you leap for Jeevan Aastha

It is in school that we are taught the basic difference between simple and compound interest. We are taught the fundamental principle that compound interest and not simple interest 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. How else does one explain people falling over each other to invest in what essentially is a fixed deposit that, depending upon the age of the investor, offers at best 7.32% per annum (p.a.) and at worst a 4.32% p.a. return?

Yes, I am talking of LIC’s Jeevan Aastha, a policy that seems to have taken the investor community by storm. The 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.

This week’s article analyses Jeevan Aastha and tries to simplify it for the ready understanding of the common investor.

Basically, Jeevan Aastha is a single premium assurance plan which offers guaranteed benefits on death or maturity. In simple terms, this policy is like a fixed deposit that offers a certain guaranteed return and a certain specific amount of insurance upon the death of the investor.

Anyone between the ages of 13 and 60 years may invest in this policy, which can be taken for a term of either 5 years or 10 years depending on one’s choice. As in a fixed deposit, the premium (investment) has to be paid once, at the beginning. In insurance jargon, this is known as a single premium plan.

Now, to understand how Jeevan Aastha works, let’s split up the investment and insurance cover. The two are mutually exclusive anyway. In other words, were the investor to survive the term of the plan, the insurance benefit offered by the policy doesn’t kick in and vice versa.

Let’s first take a 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).
Please note the significance of the words — Rs 100 per thousand per year. The usage (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, the public is lapping it up. However, note that the 10% is flat per year on a simple basis, meaning there is no interest on interest element (which by the way is the definition of compound interest). Instead the investor gets a flat 10% per 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.

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 throughout the term. First of all, the insurance amount is six times the MSA 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 tangle
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.

To sum
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.

In Nabard’s Bhavishya Nirman Bonds, Rs 8,500 grows to Rs 20,000 in 10 years, yielding an after-tax return of 8.29% p.a.

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 the Public Provident Fund (PPF) scheme. One can invest only Rs 70,000 per year in PPF, of course, whereas there is no upper limit in the case of Jeevan Aastha. Besides, PPF makes for regular investing and one has to put in a minimum of Rs 500 per year to keep the account active.

While it is true that Jeevan Aastha offers insurance along with investment, regular readers of my column would know that I do not encourage combining insurance and investment. Always buy a term plan, which is the most economical insurance that you can buy and then try and optimise your investment returns.

The author is an investment and tax advisor.