An endowment policy is like a savings plan with life cover.
It assures a risk-free and guaranteed return on maturity as long as you make the payments agreed at the inception of the policy.
It helps you save for your future, so that you are able to get a lump sum on maturity or on death before maturity.
In other words an endowment policy is a combination of Term life insurance and an Investment.
The life cover of an Endowment policy is known as Sum Assured.
How it works?
After paying-out the cost of insurance, administrative and distribution costs, the life insurance company invests the balance of the premiums to generate an income.
The surplus of the income over the expenditure of the insurance company is redistributed to all plan holders as bonus.
This bonus is usually declared as a specific proportion of sum assured or life cover.
Vested Bonus
The bonus declared is not paid to the endowment policy holder immediately as in the case of dividends.
It is added to Sum assured each year, and is payable on Maturity of the plan or on death of insured.
The process of allocating the bonus to the policy of the insured is called vesting.
The bonus so added to the sum assured at the end of every year is called Vested Bonus.
No Compounding
While the bonus is vested every year, it does not compound like a fixed deposit. Each year it accumulates as in case of simple interest.
The following example shows the effect of bonus on the sum assured on a 5 year endowment policy.
| Years | Sum Assured | Vested Bonus | Total |
| Year 1 | 100,000.00 | 2,700.00 | 102,700.00 |
| Year 2 | 100,000.00 | 2,800.00 | 105,500.00 |
| Year 3 | 100,000.00 | 2,900.00 | 108,400.00 |
| Year 4 | 100,000.00 | 2,900.00 | 111,300.00 |
| Year 5 | 100,000.00 | 3,000.00 | 114,300.00 |
| 14,300.00 |
Limitations
Like all insurance plans, the Endowment policies also have some limitations.
1. Higher Premiums in comparison to other policies
The Premiums on endowment plan are always higher than Term life or a Whole of life insurance plan. This is an expensive approach to life insurance.
2. Lower Return on Investment
Endowment plans may offer lower returns than Market linked Investments. Such returns may not beat inflation. If an investor aims to achieve real returns, Endowment plans may not be the right choice.
3. Endowment plans can be Rigid
Unlike market linked plans, endowment plans are rigid. They offer very less or no flexibility in terms on changing the plan terms or early surrender.
Summary
An endowment policy can be an ideal savings cum protection plan for risk averse investors. The capital protection and the vested bonus provide are the key benefits. It acts like a forced savings, providing a lump sum at maturity.
It may not be suitable for people looking for high life cover and other riders like critical illness benefits.
For individuals looking for income protection only; a term assurance or a whole of life insurance could be an affordable option.
You must discuss your individual situation with your financial advisor to understand if an endowment policy can help you achieve your protection and investment goals.
Alternatively you can arrange a FREE Initial meeting with me to help you setup a comprehensive financial plan and understand if this plan will help you achieve your financial goals.
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