a man sitting at a table in front of a laptop: How an expensive endowment insurance policy can strain your finances

© Venkatasubramanian K
How an expensive endowment insurance policy can strain your finances

You might think the grass is greener on the other side, but if you take the time to water your own grass, it would be just as green. Money Traps always look lush green from afar; mix this with the fear of missing out (FOMO) and it’s a deadly cocktail sure to give a money hangover.

I know Usha (name changed) for a few years now: a smart independent woman working for a multinational company, single mother blessed with two bright children. Financial troubles brewed, as life events unlocked with separation. Tackling financial obligations coming her way, she was strong enough to take them in her stride, never fading the smile on her face and her optimism.

Heavy expenses, lower savings

Usha lives in a rented apartment in a plush locality in Mumbai, near her workplace. Her elder son is studying abroad for his masters, while her younger son in doing his graduation and would also follow his elder brother. Her mother stays with her. Usha earns a fat take-home salary of Rs 6 lakh per month. After separation from her husband two apartments’ loan installments amounting to Rs 3.50 lakh per month became a burden. These EMIs itself accounted for 55 per cent of her take home pay. Besides, she shells out rent of Rs 1.30 lakh per month to accommodate her kids and her mother. After all the household spends and obligations, her monthly surplus is hardly about Rs 25000 per month. That’s just 5 per cent of her take home income.

Working at a senior management level expecting a yearly bonus of Rs 20 lakh post tax, Usha is also eligible for Employee stock options after completing three years from her joining date. She is still about two years away from her first vesting of about Rs 10 lakh. Investment in Mutual funds is Rs 16 lakh and in PMS, Rs 18 lakh. EPFO Balance is Rs 6.5 lakh.

Sacrificing today’s liquidity for a better tomorrow

As we can see, her income is excellent, but her expenses are also high. But that’s not bad per se. In her quest for a better tomorrow, she signed up for a life insurance policy where she pays an annual premium of Rs 20 lakh for 10 years and receives a fixed income from the 11th to the 20th year. And how did she plan to pay her annual premium? She assumed a certain annual bonus from her company, which she hopes to use for paying her insurance obligation for the next 10 years. She also hopes that the bonus will be stable and after sufficient period there could be more payoff through employee stock option liquidation.

But there is an obvious catch. Your employer decides bonuses and stock options. They are out of your control. You may get them one year and may not get them the following year. There are no guarantees. You would, however, be required to pay your annual insurance premium, regardless.

It is also obvious from her salary that she cannot fund her annual insurance premium of Rs 20 lakh every year from her salary. She has clearly sacrificed today’s liquidity for tomorrow’s need and by pegging to an income that is variable in nature.

Do not sacrifice liquidity

Despite earning a good income, the person still felt insecure about the future. So, for a secure financial future, she bought a large endowment insurance policy. This further suffocated her current cash situation, in addition to her high lifestyle.

No extreme is good and a balanced approach in personal finance will help reduce the blind spots, though we can never ever eliminate one. This could have been achieved in another way where saving does not turn into an obligation. Voluntary saving with discipline is good.

Three cardinal principles for you

-Never over-commit for an investment

-Never sacrifice liquidity; it’s the ultimate luxury and key to financial freedom

-80 per cent of the financial problems start with 20 per cent of the decisions

(The writer is Founder & CEO V R Wealth Advisors Pvt Ltd, a SEBI-registered investment advisory)

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