In mid-2017, I purchased an investment-linked insurance policy (ILP) that covers RM 300k in sum assured in the event of death, total permanent disability (TPD), and critical illnesses. Its annual premium is RM 1,800.
Fast forward to the present (June 2023), I learnt that I have accumulated a total of RM 4,496 in investment value for this policy. Initially, it seems to be trivial for my focus is on its RM 300k in insurance coverage. But, I began to wonder “what on earth is my RM 4,496 doing in the funds tied up with this policy?”.
Thus, I began to do a small study on my insurance policy. From it, I would like to share my findings with you so that you could:
- Calculate the true cost of an ILP policy.
- Free up cash flows for investment purposes.
- Pay its premiums with passive income derived from your portfolio.
They are as follows:
#1: 3 Components of an ILP Premium
From above, the annual premium for my ILP is RM 1,800. But that’s not my true insurance cost. To understand this, we need to first know that there are 3 major components of an ILP Premium:
- Insurance costs + Policy Fees
- Distribution costs (agent’s commission)
- Unit trust investments
The first two are costs that I incur to obtain my RM 300k insurance coverage. As for the third, it is an investment (still my money).
#2: Component 1: Insurance Costs + Policy Fees
In brief, although my annual premiums are fixed at RM 1,800 a year, I learnt the following:
- Policy fees remained fixed at RM 72 a year.
- Insurance costs grew marginally as my age increased.
Combined, the amount of insurance costs and policy fees I paid annually are:
#3: Component 2: Distribution Costs
My cost has declined in line with the commission rate fixed by my insurer to my insurance agent. Eventually, this cost would be zero beginning in Year 7 because my insurance agent is entitled to a commission for Year 1-6 of my premiums. So personally, the amount of annual distribution costs I paid are as follows:
#4: My Actual Insurance Costs
Combining Component 1 and 2, my annual insurance costs in 2018-2022 are:
Although my costs are lower than RM 1,800 in annual premiums, I could deduct the full RM 1,800 in tax reliefs, which is worth at least RM 360 in tax savings per annum (based on 20+% in maximum tax bracket). So my net actual costs for my ILP are as follows:
Essentially, in 2021-2022, I had paid less than RM 50 a month for my ILP.
#5: Unit Trust Investments
I’ve noticed that the investment value of my funds tied to my ILP began to build up in Year 4 onwards as my distribution costs (Component 2) reduced. So based on my insurance statements, the end investment values of my funds are:
As stated, the investment value of my fund stands at RM 4,496 in June 2023.
So, how did my fund perform?
Well, it is quite hard to calculate. Fund performance is typically based on capital gain or loss. I did not receive an income or yield from my fund. So, it is a case of either keeping them and hoping for capital gains or withdrawing them to invest for cash flow + capital gains. This leads us to:
#6: Withdrawal Rules
Although RM 4,496 in investment value is “my money”, I can’t withdraw the full sum as I please. There are 2 things to consider:
- I need to keep at least RM 1,000 in my fund to keep the policy running.
- I need my beneficiaries’ approval to withdraw from my fund.
Hence, at most, I may choose to withdraw up to RM 3,000 from my own fund.
#7: The Original Purpose of that “RM 3,000”
Ideally, my RM 3,000 is intended as a cash reserve to pay for my ever-increasing insurance cost (Component 1) as I continue to age over time. Hence, the choice of investment vehicles should have the following characteristics:
- Capital preservation (it’s meant for future hikes in insurance costs).
- Income productive (receive income to pay for insurance costs).
There are many investment vehicles. But, for the sake of our discussion, I would just use EPF for it is capital guaranteed and pays out 5%-6% in annual dividends to its contributors. Hence, I get to build on my retirement fund and still obtain a protection policy that covers RM 300k for major life events.
Conclusion:
In summary, I have learnt of the following:
- There are 3 components to take note of in an ILP’s premium.
- Actual costs = Insurance + Policy Fees + Distribution Costs – Tax Relief
- Fund investment value builds up significantly in Year 4 onwards.
- You need to keep a sum in your fund to keep your policy “alive”.
- You need your beneficiaries’ approval to withdraw the sum.
- You may choose to invest the sum for cash returns + capital gains.
