Unlocking the Future: The Financial Odyssey from Fixed Deposits to Life Insurance Enlightenment

Picture this: You're standing at a crossroads, the sun setting behind the horizon, painting the sky with hues of deep oranges and purples. In one hand, you hold the security of a fixed deposit slip, and in the other, the promise of an insurance policy. It's the kind of decision that could define your financial future, and the clock's ticking.

Let me tell you a tale of two wise folks from our very own vibrant city, each with a pot of gold amounting to a hefty Rs. 60 Lakhs, ready to be planted in the fertile land of investments. One chose the well-trodden path of bank fixed deposits, lured by the comfort of familiarity. The other, intrigued by the allure of a traditional endowment insurance plan, ventured down a road less traveled.

As the years rolled by, the landscape of economy and policy shifted like the sands of the Thar, bringing with it winds of change that reshaped the value of their choices. Interest rates, much like the monsoons, proved fickle, while taxes, as certain as the summer heat, gnawed away at the returns from the bank deposits.

Now, as we sit under the starry blanket of the present, sipping on our chai, let's unravel their stories. Let's delve into the numbers, the cold hard math, and the warm, hopeful whispers of future gains. But, hold onto your cups, because we won't spoil the ending just yet. Instead, let's embark on a journey through time, numbers, and the subtle art of investment, that might just lead you to the treasure chest best suited for your tomorrow.

Grab your map and your sense of adventure; we're about to set sail on the financial seas, seeking the best investment island to dock our hard-earned money. Will it be the sturdy shores of the fixed deposit or the beckoning bays of the insurance plan? Stay with me, and let's find out together.

Part One

We analyzed 1-year, 3-year, 5-year, and 10-year fixed deposit interest rates of a top PSU Bank and here are our findings for 3-year periods in particular:

• The dataset spans 15.98 years (rounded from 15.978), starting from the earliest date in the data to the latest. The beginning date was 04Jan2008 when the rate was 8.50% and the last date of change was 27Dec2023 with the interest rate at 6.75%.
• The simple average annual rate of change in interest rates during this period is approximately -0.1095%. It indicates a slight downward trend year over year. The standard deviation of the interest rate changes for the entire period is 1.27%.
• Projecting this average change forward, the interest rate is expected to decline by about 1.314% over 12 years. Hence, if the current interest rate is 6.75%, it is projected to be approximately 5.436% in 12 years.
• For an individual in the 20% tax slab, the net interest rate after taxes would be reduced to about 4.349%.
• For someone in the 30% tax slab, with an additional 4% Cess, making it a total of 31.20% tax, the net return or interest rate would further reduce to approximately 3.740%.

1. Descriptive Statistics:The average (mean) interest rate over the 16-year period is 7.32%. The interest rates have a standard deviation (volatility) of 1.27%, which indicates how much the rates vary from the average. The minimum recorded interest rate is 5.30%, while the maximum is 9.75%.
2. Trend:The slope of the trend line is approximately -0.042% per period (with each period being the interval between rate changes), indicating a slight overall decrease in interest rates over time.
3. Volatility:The standard deviation of 1.27% suggests that while there's been a general trend of decreasing rates, there have been periods of significant fluctuation.
4. Periods of Increase vs. Decrease:There were 19 periods when the interest rates increased.There were 28 periods when the interest rates decreased. This indicates that decreases were more frequent than increases.
5. Largest Changes:The largest single increase in interest rates was 1.25%. The largest single decrease was also 1.25%, which shows that there have been periods of significant volatility.
6. Duration Between Changes:On average, the duration between rate changes was about 70 days. This relatively short average duration suggests that rate changes are quite frequent, which adds an element of unpredictability to the interest rates.

Part Two

We have studied an endowment insurance plan that gives regular annual cash inflows for a very long period, which can be compared to a regular income or pension.

In this example, the annual premium is Rs. 5 Lakhs. In case of life insurance plans such as the one in this example, the GST rate is 4.5% on the first year's premium and 2.25% from the second year onwards. That means, The first year premium is Rs. 522500 and the subsequent yearly premiums are Rs. 511250. In this policy, premiums are payable for a period of 12 years, at the beginnings of the years i.e. in advance. After paying premiums for 12 years, the policy holder must wait for 2 years. From the third year onwards i.e. from the 15th year since the first premium payment, an yearly income of Rs. 645000 is paid to the policy holder for a period of 30 years. Also, all the premiums paid excluding GST i.e. Rs. 60 Lakhs for 12 years are returned at the end of the 30-year income period or the total policy period of 45 years. Now, let us dissect and summarise this.

1. Premium Payments:The first-year premium with GST is Rs. 522,500.For the next 11 years, the annual premium with GST is Rs. 511,250. Total GST paid over 12 years would be Rs. 5,22,500 + 11 * Rs. 11,250 = Rs. 5,74,750. Total premiums paid excluding GST over 12 years is Rs. 60 lakhs.
2. Waiting Period:There is a 2-year waiting period after the 12 years of premium payment during which no benefits are paid.
3. Regular Income:From the 15th year onwards, an annual income of Rs. 645,000 is paid to the policyholder for 30 years. Total income received over 30 years would be Rs. 645,000 * 30 = Rs. 1,93,50,000.
4. Return of Premium:At the end of the 30-year income period, the premiums paid (excluding GST) are returned, amounting to Rs. 60 lakhs.

Part Three

When comparing a traditional endowment insurance plan to a fixed deposit, it's essential to consider the long-term implications of the interest rates, tax effects, and the nature of returns. Here is a comparative analysis, incorporating the example of interest rates declining over time for fixed deposits and the stable IRR for the insurance plan.

Fixed Deposits: Declining Interest Rates and Taxation

• Interest Rate Decline: The historical trend indicates a decline in fixed deposit rates from 8.50% to 6.75% over 16 years, with an anticipated further decline to 5.44% over the next 12 years.
• Post-Tax Returns: The returns from fixed deposits are taxable, which further reduces the net yield, especially for those in higher tax brackets. As the interest rates continue to decline, the post-tax return will further diminish.
• Inflation Impact: Fixed deposit returns might not keep pace with inflation, which can erode the purchasing power of the interest earned.

Insurance Plan: Stable IRR and Tax Efficiency

• Stable IRR: The insurance plan offers a stable IRR of 6.10% over 45 years, which is not subject to fluctuation like fixed deposit interest rates.
• Tax-Free Returns: The returns from the insurance plan are exempt from tax under Section 10(10D), which means the IRR of 6.10% is a net figure, enhancing its attractiveness.
• Return of Premium: The insurance plan also returns the premiums paid (excluding GST) at the end of the policy term, effectively increasing the total value received.

Illustrative Example:

Let's assume two individuals, Person A and Person B, both have Rs. 60 Lakhs to invest. Person A chooses the fixed deposit route, while Person B opts for the insurance plan.

• Person A (Fixed Deposit):Initial investment: Rs. 60 LakhsInterest rate: Starts at 6.75%, declining by 0.11% p.a. (3-year renewals)Taxation: Subject to tax, which reduces the effective interest rate furtherLong-term return: As the interest rates decline, the returns diminish over time. The net yield after 45 years will be significantly lower than the nominal rate due to taxation and a continuous decline in interest rates.
• Person B (Insurance Plan):Premiums paid: Rs. 60 Lakhs over 12 yearsIRR: A steady 6.10% net of GST, tax-freeAdditional benefits: Premiums returned at the end of the term, annual tax-free income for 30 years, and tax benefits on premiums paid under Section 80C

After 45 years, Person A’s investment in fixed deposits could potentially be worth much less in real terms, considering the impact of inflation, declining interest rates, and taxation. In contrast, Person B’s insurance plan provides tax-free returns at a stable rate, which not only preserves but possibly enhances purchasing power over time.

For someone seeking to make an immediate and informed decision, the insurance plan offers several advantages over the fixed deposit, notably tax efficiency, predictability of returns, and the potential to better keep pace with inflation. The insurance plan would be particularly beneficial for individuals in higher tax brackets and those who are looking for a stable, long-term return on their investment without the worry of interest rate fluctuations.

Conclusion

As we draw the curtains on our exploratory journey through the meandering paths of investment landscapes, it's hard not to be swayed by the compelling charm of the traditional endowment insurance plan. In a world where certainty is as elusive as a mirage in the desert, this policy stands as an oasis of assurance. The gradual but steady erosion of fixed deposit rates, taxed further by the hands of fiscal policies, contrasts starkly with the tax-free, unwavering promise of the insurance plan. In the marathon of financial endurance, the life insurance policy emerges not just as a mere participant but as a torchbearer, guiding us towards a future where the fruits of our labor are not just protected but amplified. So, if the tale of numbers has enchanted you, and the future is a canvas you wish to paint with the brush of security and prosperity, it might just be time to pen your own story with the ink of life insurance. After all, in the grand tapestry of time, a choice that ripens with age and remains unscathed by the claws of taxation is not just a choice—it's a legacy. #bsreddy #cfp #prosavers