FD vs life insurance: Which investment suits you?

Comparing a fixed deposit to a life insurance policy is like comparing a t-shirt with jeans – each serves its own purpose. However, just like both the t-shirt and the jeans are pieces of clothing, and together make up your wardrobe, fixed deposits and life insurance are important investment products that should be a part of your investment portfolio. Let’s first understand the purpose of each. 

What is a fixed deposit?

Fixed deposit or FD is a financial product offered by banks and other financial institutions where you can park your savings and earn interest on it. The interest rate on fixed deposits is higher than the interest rate offered on the bank savings account balance. 

When investors choose fixed deposits over investments in the stock market, they usually do so because they are looking for a low-risk and liquid investment. Unlike the stock market, there is no volatility with fixed deposits. The interest rate is fixed for the entire tenure of the investment, and you know exactly what your ROI (return on investment) is going to be the day you make your investment. 

What is life insurance?

Life insurance is a financial product that is designed to provide financial protection to your loved ones in case the worst happens to you. There are several types of life insurance policies, but essentially, they each require the investor to pay a certain amount of premium each year for a sum assured. This sum assured is paid out to the policyholder’s family in case of their demise during the policy period. 

So, when you are investing in a life insurance policy, you are financially guarding your family against the uncertainty of life. There are different types of life insurance policies that can help you with other financial goals such as savings and wealth generation. For instance, Unit-Linked Insurance Plans (ULIPs), in addition to life cover, also allow you to invest a part of your money in equity and debt instruments to earn returns. 

FD vs life insurance

Based on the essential investment metrics, here’s how fixed deposits and life insurance policies differ:

• Tenure

When it comes to fixed deposits, you can choose a tenure of anywhere between seven days to 10 years. Depending on the type of life insurance policy, the tenure can range from 5 years to your lifetime. 

• Returns

Currently, depending on the financial institution, the fixed deposit interest rate is between 5% to 7%. Traditionally, life insurance policies are not meant to generate returns in the typical sense. The return on a life insurance policy is really the protection against life contingencies it offers. However, ULIPs can give returns of 8% to 12% depending on asset allocation. 

• Tax benefits

Regular fixed deposits don’t have any tax benefit. However, there is a tax-saving FD option that comes with a five-year lock-in period. It allows you to claim a tax deduction of up to Rs. 1.5 lakh under section 80C of the Income Tax Act, 1961. You can claim this deduction for life insurance policies as well. In addition to section 80C, life insurance policies also come with a tax benefit under section 80D where the sum assured payout is tax-exempt.

• Liquidity

Fixed deposits are highly liquid. While you may be charged a penalty that will be offset from the interest earned, you can withdraw from your fixed deposit at any point before the tenure. Tax saving FDs are an exception. You can also take out loans against your regular fixed deposit investment. Partial withdrawals are possible in life insurance subject to certain conditions based on the type of policy you have opted for.

Conclusion

As you can tell, the way both fixed deposits and life insurance policies are designed is so that each takes care of an important financial need. For instance, if you have a lumpsum amount of money now which you know you will be requiring soon, say three months from now, you can invest it in an FD instead of letting it sit idle. Life insurance, on the other hand, is a crucial investment to have in place irrespective of your life stage.