Have at least a 10-year horizon if you buy an endowment plan

Published in Mint on 12th Aug 2014, Written by Abhishek Bondia

Can a life cover work as collateral security for a loan?
—Thomas George

Theoretically, life covers that acquire a surrender value can be conditionally assigned to a bank and used as collateral. The collateral will kick in if the loan is not paid. In such cases, the bank can surrender the insurance and claim the surrender value.
Practically, however, life insurance is not preferred by banks because the surrender value is uncertain. The surrender value depends upon the year of surrender. Also, the borrower may not pay up future premiums, which, in turn, erodes the value of collateral.
Apart from this, most lenders now insist on a term life insurance cover equal to the loan value. This is only an additional safeguard in the event of death of the borrower. A normal term cover has no surrender value so cannot be used as collateral.

What factors should be considered while choosing the duration of an endowment plan?
—Jaipal Shetty

Endowment plan is a long-term investment. The purpose of an endowment plan is to force regular savings, create an asset for a long-term liability or expenditure, and provide life insurance to cover the specific liability if you die prematurely. Hence, end date of an endowment plan is earlier of the two:
a) Date till when you can comfortably pay regular premiums. For example, you do not want an endowment plan to continue post-retirement.
b) Date when the planned expenditure or liability matures, for example, child’s education or marriage.
Generally, one should have at least a 10-year horizon if you are buying an endowment plan.

What is a gratuity scheme and what are its benefits?
—Latha

Employers pay a gratuity amount if an employee leaves after working for at least five years in the company. A gratuity scheme helps an employer plan for this liability.
Based on the number of employees, average salary and average tenure, the insurer does an actuarial estimate of the liability. The employer makes a regular annual contribution to fund this liability.
There are three key benefits of a gratuity scheme. First, it helps plan for an erratic liability through a regular annual contribution. Second, the contribution to a gratuity fund is tax deductible. And, third, these funds generate healthy returns (upwards of 8%).

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