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.