With a premium holiday, your ILP is kept in force. This is different from other policies, whereby stopping your premiums will result in your policy being terminated – at massive financial cost.
Disadvantages of an ILP
1. No guaranteed returns
Unlike some other insurance plans, ILPs don’t guarantee any returns. This is why it’s considered a higher-risk product. The reason why an ILP can offer flexibility in premium continuity and insurance coverage, and potentially higher returns, is also the same reason behind its largest disadvantage – the returns from your ILP are not guaranteed.
This is not to say that you will definitely lose your capital when you purchase an ILP. Rather, it simply means your insurer is not beholden to provide you with any payouts when you decide to surrender your policy, apart from what your units are worth at the time of surrender.
Depending on your circumstances and your financial goals, this could render ILPs unsuitable for you. If you cannot afford to lose part or all of your capital, you should consider a plan that provides guaranteed returns.
2. Hefty fees and charges
Your investment returns would not only depend on the performance of the fund, but also the fees that you incur. The fees eat into your investment returns. For example, investment returns of 8% would only be 3% if the costs add up to 5%. For this reason, robo-advisors appeal to many investors with their low management fees of less than 1%.
With an ILP, the investments that you undertake come with high cost. This is due to the sales costs charged by the insurer, fund’s management fee and in some cases, surrender charges amongst other fees.
Depending on the structure of the plan, there are also some ILPs that allocate premiums in the early years to pay for initial expenses such as distribution costs and administrative costs, leaving little funds available to purchase units of the fund.
Do keep a lookout for such ILPs as it could be a high cost to pay, especially when other investment types such as robo-advisors simply charge a single management fee, without additional fees for components such as account opening.
3. May have to reduce insurance coverage
Due to the way ILPs work, you may need to reduce your insurance coverage. This could be problematic for some.
The cost of insurance rises with age. As we get older, the risk of certain diseases and conditions increases. Correspondingly, it is more expensive to insure a 40-year-old, compared to say a 20-year-old, for the same coverage.
For this reason, you may encounter a situation where your ILP units are no longer sufficient to pay for both your coverage and your investments – even if you are still paying premiums. At this point, you are paying for insurance only, with very little – if any – of your premiums being invested.
Essentially, you’re paying for a glorified (and possibly overpriced) insurance plan with little to no monetary growth. This defeats the purpose of signing up for an ILP in the first place!
In order to free up your units such that your ILP continues to accrue value, you may have to reduce your insurance coverage. This could be a risky move, especially if you’ll be left with insufficient insurance protection or worse, having the policy lapse when you are unable to afford the high cost due to a lack of income.
Having a yearly review with your financial planner is crucial. As your life stages change, so will your risk tolerance, making it necessary to adjust the coverage, supplementing protection gaps through other forms of insurance, and possibly make a fund switch to align with your initial financial goals alongside ever-changing market conditions.
4. Complexity of the plans and their charges
As you might have realised by now, ILPs are a complex type of insurance-cum-investment plan. From the way the plan is structured, to the fees involved, the different types of ILPs available, the options you have when you’re on the plan as well as the funds available; it’s challenging to fully grasp all the details that an ILP entails.
A look at the policy documents will highlight the many different kinds of fees involved. If you’re not comfortable selecting the ILP sub-funds, you could consider other investment options that provide you with a diversified portfolio based on your risk appetite and investment goals.
Things to consider before buying an ILP
If you’re mulling over whether you should really purchase an ILP, here are some factors you can consider:
- Financial situation: How much will the ILP cost and can you afford it in the coming years?
- Purpose of purchasing an ILP: Why are you considering an ILP? Are you looking for life coverage or are you looking to grow your wealth? There are alternatives that could prove more effective for those respective purposes.
- Insurance coverage required: How much coverage are you looking for? Some ILPs can provide more holistic coverage that includes death, TPD and terminal illnesses, while others focus on the investment component and provide a basic lump sum payout upon death. If you are looking for higher coverage, a better option could be to purchase a term life plan instead.
- Availability of other options: With investment products being highly accessible these days, you could take the time to read up on insurance and investments separately to find products that best suit your needs.
For whom are ILPs best for?
An ILP could be a convenient way for you to check all the boxes — insurance coverage and wealth accumulation, coupled with liquidity, access to a huge pool of funds catered to your risk profile and the flexibility to switch funds.
However, due to the high costs and lack of guaranteed returns, you should ideally have a longer investment horizon in order to ride out market volatility in the long term. Furthermore, some ILPs have a minimum investment period or minimum holding amount that would require you to ensure that you can afford the plan.
Also, you should not be dependent on your ILP for your retirement as the returns are projected and there is no guaranteed cash value. The cost of the insurance coverage would also increase with age, making ILPs more suitable for those with time on their side.
Differences between ILPs and other life insurance plans
There are two types of life insurance plans that you can consider to provide you with life coverage instead of an ILP: whole life vs term life insurance. Both of these life insurance types offer different value propositions.
Whole life: Whole life insurance plans provide the life assured with insurance coverage for life. This could be up till 99 years old, or until death, giving your dependents lifelong protection.
There are similarities between a whole life insurance plan and an ILP. Participating whole life plans can offer bonuses that are dependent on the performance of the participating fund. Unlike an ILP whose surrender value is purely based on the performance of the funds, whole life plans can offer guaranteed cash value even if you choose to surrender the plan in the future.
However, this cash value can only be withdrawn when you surrender the policy, which means that you will be losing your life coverage. ILPs on the other hand, have the option for a partial withdrawal while still allowing you to retain your insurance coverage.
While there are many reasons why people choose whole life plans, they are considerably more expensive compared to term life plans. This is why some people opt to buy term insurance and invest the rest.
Term insurance: High coverage, low cost. Term insurance plans provide coverage for a specified period. They are also purely for protection and do not offer any cash value, making them a fairly straightforward type of life insurance product.
Choosing between the two types would ultimately depend on your personal preference and coverage requirements. Whole life and term life plans can also be used hand in hand to help you maximise your coverage and accumulate wealth.
Investment alternatives to ILPs
We’ve covered life insurance in the section above. While some people might consider an ILP for its investment returns, there are other alternatives available today that come at low cost.
If you’re looking for ways to grow your money, here are some options for you to consider.
Robo-advisors: Robo-advisors have become a go-to option for young investors, offering investment portfolios that can be curated based on factors such as your risk tolerance, investment horizon and investment goals.
These portfolios are also offered at low cost, with low or no minimum investment amount requirements, lowering the barrier of entry for new investors. Funds can be deposited and withdrawn with no additional cost.
You can also use not just your cash, but also your CPF money or Supplementary Retirement Scheme (SRS) funds to invest, depending on the robo-advisor.
Exchange Traded Funds (ETFs): A type of security that trades on the financial markets, ETFs typically track an index and can offer diversification.
Real Estate Investment Trusts (REITs): REITs are a popular investment vehicle amongst Singaporean investors, offering high dividend yields which make them a great asset to bring in passive income.
Unit trusts: Unit trusts, also known as mutual funds, can easily be purchased on financial platforms. You can also invest in unit trusts through robo-advisors.
Stocks: You can select individual stocks to make up your investment portfolio. To get started, open your Central Depository (CDP) account and brokerage account.
If you’re looking for products with lower risk but also modest returns, you can also consider products such as endowment plans, fixed deposits, Singapore Savings Bonds (SSBs) and insurance savings plans.
Ideally, your financial portfolio should be made up of different financial instruments, which come together to serve all your needs. It is dangerous to have only one or two types of plans, and expect to be fully covered; this holds true for any insurance or investment plans, and not just ILPs.
All in all, ILPs offer distinct advantages, but also come with some pretty gnarly risks. To help you plan how best to employ an ILP (or determine if such a plan is even suitable for you), seek the advice of a qualified financial adviser or wealth manager.
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