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In India, banks and insurance firms are perpetually launching new financial products in the effort to win customers. The Guaranteed Income Plan (GIP) is one of the products that have become popular over the last few years. On paper, these schemes are safe, stable and appealing – who would not like to have a monthly or annual payment guaranteed? However, upon digging a bit deeper you will discover that these plans are not as good as they are being sold.
Most of the private banks aggressively market these plans on the customers and at times fail to explain the negative side of the plans clearly to them. Unluckily, this is the trap in which lots of individuals get entangled and spend years of their lives in keeping their money locked away only to find themselves regretting the move.
This paper will describe the drawbacks to guaranteed income schemes, the reason why private banks are so keen to sell them to you and the alternatives that you should adopt to ensure your hard-earned cash is not squandered.
The Guaranteed Income Plan, what is it?
Guaranteed Income Plan is normally a life insurance and savings combination. You make regular payments at a certain time (say 5-10 years), and upon maturity of the policy, you begin to receive a specified amount of income on a monthly or annual basis.
This is fantastic at face value:
- Periodic after-tax earnings.
- Some insurance coverage
- Tax benefits under Section 80C
The reality is though, the payoff on these plans is typically significantly lower than other types of investments and your investment is very long term.
Significant Cons of Guaranteed Income Plans.
1. Poor Performance as compared to alternative investments
The guaranteed income plans typically offer an internal rate of return (IRR) of between 4-6%/per annum. That is barely superior to a savings account or a fixed deposit – and much lower than inflation or other investments such as mutual funds, PPF, or even long-term fixed deposits.
Assuming inflation levels are at an average of 6% and you have a plan that yields 5% a year, you are not actually earning, you are simply keeping up with it, or even losing a lot of the ability to buy things as the years go by.
2. Long Lock-in Period
In such plans, you usually have to pay premiums over a long period of time-7-10 years- and then again you must wait even longer before getting the guaranteed payouts.
You cannot easily withdraw without being imposed harsh penalties or surrender fees especially when you require money in between to cater to such emergencies as medical, education or business opportunities. As though in a lock, your money is away and this restricts your financial flexibility.
3. Lack of Transparency
These plans are frequently sold by the private banks and insurance agents as investment plus insurance. Nonetheless, these plans are complex in the manner they are designed. Your premium fee is divided into charges, insurance, and investment, although the customer does not always get a clear understanding of how much of his/her money is actually growing. Most individuals believe that they are investing in a high paying venture, only to realize that they are in fact situated in a low paying insurance scheme with terms and conditions that favor the insurer on a significant basis.
4. Commissions and Charges are high
High commission paid to insurance companies is one of the primary factors why the private banks push such plans so vigorously. In contrast to a fixed deposit, mutual fund or PPF which provide minimal or no commission, selling a Guaranteed Income Plan may provide agents and banks with a substantial initial commission, up to 20-30 percent of the first-year premium.
This implies that when you make an investment [?]1 lakh, a sizable portion of your funds may head directly to the bank or agent, rather than directly to your actual investment. This of course lowers your eventual returns.
5. False Sense of Security
The word guaranteed is safe and in the world of finance, being safe does not necessarily mean growth. Something being guaranteed can not be the best use of your money.
By committing to a low-yield program you may fail to seize superior prospects such as equity mutual funds, NPS and even government-approved schemes that would allow higher returns with a reasonable level of safety.
6. Not Fit to All Ages
These plans are marketed to elderly people, housewives or young workers by many banks without determining their true financial objectives. For example:
- A young professional may require the creation of wealth, as opposed to slow guaranteed income.
- An elderly citizen may wish to use more flexible tools such as SCSS (Senior Citizens Savings Scheme) or FDs, which are more liquid and less risky.
However, since the bank employees are under targets of selling products, they tend to sell the same product to all people even when the product does not suit the financial needs of that individual.
Why Private Banks Force Customers to Buy These Plans
Banks are no longer banks rather they are distributors of insurance and investment products too. They also make extra revenue through buying of policies.
- Insurance company high commission incentives.
- Sales goals of employees monthly or quarterly.
- Compulsions to cross-sell financial products on existing customers.
- Weak laws on misselling.
In other instances, bank employees employ fraudulent strategies- like making the policy look like a fixed deposit with higher rates or obligatory with a loan or credit card. Such practices commonly referred to as misselling are harmful to the customers yet they increase the profit of the bank.
How to Guard against these Fallacies.
- Never accept the explanation of the bank representative and always read the policy document.
- Pre-investment calculation of the IRR (effective return). When it is lower than inflation or other, less risky alternatives, rethink.
- Insurance is not to be confused with investment. Take buy term insurance to be insured and mutual funds/FDs to grow.
- Get impartial recommendation of a financial planner who does not make a commission on product sales.
- Always avoid signing anything in a rush- get to know more about the product.
Final Thoughts
The marketed Guaranteed Income Plans are safe and intelligent investments but the truth is not so attractive. They put your money in a safe deposit box, provide a low rate of return and best of all benefit the bank or insurance company rather than you.
These plans are heavily marketed by the private banks since they receive huge commissions, rather than because it is good in your financial health. As a customer, one should be informed, pose the right questions, and should never be forced by any salesperson or sales team to purchase something that he or she does not know or does not need.
Your hard-earned money should be worth more, ensure that it is working in your favor, and not on the sales target of a certain person.