Buy Term Invest The Rest and reduce taxesRecently one of my clients wants to invest in an ILP (Investment-linked policy) after hearing from his friend who is an insurance agent. He wanted to buy this ILP from me and asked for my opinion and I went on to work out the sums.
Budget: S$1,200 per mth
The proposed ILP's quote has embedded Critical illness waiver of premium, which means upon diagnosis of critical illness will waive the future premiums required to fund the investment. Total investment capital over 25 years is S$360,000 (S$1,200 x 12 month x 25 years), and insurance coverage is on a gradual reducing basis.
Is there a better way to do it? Yes, I break up the monthly sum of $1,200 into a term insurance (S$300,000 protection for death, TPD, Critical illness cover) and feeding into my UT-RSP portfolio using a "
Drip in money" strategy
1) S$105 for term insurance (S$300,000 protection for death, TPD, Critical illness cover): S$300,000 coverage is constant throughout, while the ILP is on reducing basis.
2) S$1095 for investment -"
Drip in money" strategy
(Client can also divert this money into
SRS and invest from
SRS and saves on income tax which is about $500 & above, based on S$41,000 chargeable income).
note: $500 savings is almost 5 months' worth of term insurance premiums.
RESULT:
A) Based on ILP's 5% and 9% projection, the end amount are S$484,597 and S$826,145 respectively.
B) Based on my UT-RSP's 5% and 9% projection, the end amount are S$625,225 and S$1,128,995 respectively.
See graph below:-
What's more, if this client should unfortunately be
diagnosed with critical illness, at let's say on the 21st year of the plan, there is huge difference in the total NAV (Net Asset Value) of the plan:-
a) ILP: payout is only the NAV (estimated S$590,933 at 21st year) of the underlying funds; with the "Critical illness waiver of premium" rider, although client does not need to pay anymore future premiums, he can only expect to receive S$826,145 at the end of 25 years, based on 9% projection.
b) UT-RSP + Term insurance: Upon diagnosis of critical illness, payout from insurer is S$300,000. Based on my UT-RSP's 9% projection, NAV is estimated at S$756,626. If client decides not to invest anymore upon illness, his takeaway amount would be S$1,056,626 at the 21st year. NAV of UT-RSP portfolio at 25th year is estimated at S$1,128,995 (if there is no critical-illness-insurance-claim)
Comparison: "UT + Term insurance" achieves
much better (78.8% better) than ILP when there is an insurance payout; "UT + Term insurance" achieves
better (36.7% better) than ILP if there is no insurance payout.
However, what ILP triumphs over "UT-RSP+Term insurance" is the commission payout to the agent/ adviser.
Based on the above example, ILP pays S$7200 to the agent in the first year, "UT-RSP+Term insurance" pays S$800 to the agent. Difference: S$6,400 (89% lesser)
My client has decided not to go with the ILP after my explanation. He asked me why I did this, I said I'd better do what I think is best and right for my clients. My commission will come in the form of more referral businesses in the longer run.
Note: Term insurance premiums (or any insurance, for that matter) is subjected to age and insurability, the client's age in the above example is 26 as of 05Jul2008, smoker with no pre-existing conditions.
Term insurance has a specific maturity date and some provide coverage of up to age 65 only. The above BTITR strategy is suitable for people who has long term investment horizon (at least 10 years) and be able to stomach some risk and volatility in the markets. This strategic portfolio should form only part of a person's retirement plan, it may be advisable that one has a conventional whole-life insurance plan with limited payment terms for long term protection plan. In my opinion,
ILP should be considered only when there is absolutely no other choice available.
