SEBI registered Investment advisor (RIA) with Registration number – INA 000000342.
Do not buy Life insurance this year to save tax

We are in the Life insurance season, where we will be getting maximum sales calls from agents with very attractive offers including tax benefits. Your bank also will be pestering you to take policies, because most of the banks are now distributors of insurance and mutual funds. Almost 70% of the life insurance policies sold in India are sold in the last 3- 4 months of the financial year. This indicates that most of these sales are happening for saving tax. Majority of the buyers will not study much about the policy, if this policy is going to help them to save tax.

Beware, if you are doing so this year! Your policy may turn out to be a liability for long term, if you don’t think twice this year. Direct Tax Code (DTC) which is likely to be effective from 1st April. 2012, may change the way, insurance is enjoying the income tax benefits.

What are the changes proposed in the Direct Tax Code?

At present life insurance premium paid for self, spouse and children upto 1 Lakh in a year can be claimed for deduction from the taxable income under Sec. 80C. This is going to change. As per the current draft of the DTC, the upper limit is 50,000/- in a year that too along with Health Insurance premium and tuition fee for children!

Let us take the case of Nikhil with 2 school going children. He spends around 40,000/- in a year on school fee. He had taken a family floater medical insurance over and above his company provided mediclaim. He pays around 8000/- annually for this. He is paying 5000/- as annual premium for an endowment policy, sold by his uncle 7 years back. The total of all these comes to 53,000/-. His income tax exemption will be limited to 50,000/- only as per the Direct Tax code!

Most of us will be having some existing policies, where we have to pay renewal premium every year.  Health insurance is becoming a must now days with cost of health care increasing day by day. If you are paying for children education, that itself will take a lion share from this 50,000 limit. So there is not much head room left for a new policy to save tax.

Not all policies are eligible for tax benefits!

If your policy is not offering insurance cover of atleast 20 times of the annual premium, the premium will not be eligible for tax benefits. In such a policy, even your maturity amount will be taxable! So better avoid.

Most of the endowment/money back policies now available in the market will be out of the tax benefits, as per this condition. If you are aged 30 and  buying a 20 year money back policy from LIC, for 5 Lakhs Sum Insured, the annual premium works out to Rs.31,398/-.Since the cover offered by this policy is less than 20times of the premium, it will not be eligible for tax benefits. Moreover, the maturity benefits from this policy will be taxable too!

Partial withdrawals and surrenders will be taxable

At present, there is a partial withdrawal facility in ULIP policies which allows you to withdraw some amount in between (generally after 5 years) to meet any emergency. This is tax free as of now. Direct tax code proposes to bring this also into the tax net. Also, if you surrender the policy before the maturity date, that also will be taxable as per the proposed Direct Tax Code.

The question is regarding the effective date of implementation of the Direct Tax Code – will it be from 1st April. 2012 as proposed now or not. Equally important is to know, whether such rules are applicable to the existing policies also or for the new policies taken after the effective date.

Anyway, it is better to adopt a wait and watch approach this season. Otherwise, you may be in a trap. Term insurance will be a better bet to go for which offers very high cover at the lowest cost.

6 Comments

  • prem Posted December 23, 2011 10:32 am

    Hi,
    Its a fact that most of these insurance schemes which clubbs investment and insurance are not good. I am guessing that when the whole idea of insurance started off in India,there were no takers and for people to have some kind of insurance,govt. encouraged clubbing savings and insurance to generate common man’s interest.Now most of the people are under insured and wrongly insured since the insurance coverage offered by these clubbed plans are lesser.Forget the nominal rate of interest on the investment part.
    Now my question is why is no one including govt,IRDA and financial consultants like you not coming up with any measure to educate the common man.You might have published some article in the past,but is there not a way some where to educate and may be to scrap some of the worst plans circulating in the market….
    Your thoghts and an article regarding this in the coming weeks would be much appreciated.

    Many Thanks
    Prem

    • admin Posted December 26, 2011 12:26 pm

      The issue here is the financial illiteracy in India. The government is having many other priorities and financial education in India is a neglected topic.Regulator is very slow in this sector and lots of customers are losing their hard earned money.
      Can You specify which topics, you wish to cover in the article, as suggested by you?

  • Gaurav Jain Posted January 28, 2012 7:34 pm

    How is LIC Jeevan Anand Policy ? Is it worth buying ?

    • admin Posted February 2, 2012 10:39 am

      Not at all from the investment angle. Buy Term insurance policies and invest through mutual funds for wealth creation.

      • Dornadula V Umashankar Posted February 4, 2012 10:34 pm

        Could you specify some of the best policies for Term Insurance as well as mediclaim.

        • admin Posted February 9, 2012 10:57 am

          For Term insurance, I-Life policy of Aviva is a good bet. For Mediclaim, Apollo Munich offers Easy Health Policies with lot of good features and life time renewal.

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