Budget 2012 - Income tax and Life Insurance

The Union Budget 2012 has been the focal point of the articles in our blog over the past few days. We have covered various aspects of Budget 2012 and the Tax implications on the Indian Citizen. Now, it is time to take a look at how the Budget 2012 impacts the Life Insurance section of Income Tax. Though there was no significant announcement about the Insurance Sector in our 2012 budget, there is one small change that waw tucked away in the corners of the budget. This change will have much bigger consequences. The purpose of this post is to cover those areas…

Before We Begin:

Insurance is nothing but an agreement between the insurer (The Insurance Company) and the insured (You) to pay an amount as compensation if any unexpected event occurs. This amount may vary from a few hundred to even a few crores. The maximum amount the insured person can claim depends on the amount agreed upon as per the insurance policy

To read more about Life Insurance Click Here.

What this Small Change?

All Regular Premium Life Insurance Policies issued after April 1st (Except Pension Plans) must offer a protection cover of at least 10 times the annual premium. Otherwise, they will not be eligible for Tax benefits under Section 80C.

Note: Until now, the mandated cover was five times the annual premium

What will be the Impact on the Common Tax Payer?

The Impact will be pretty big. All Insurance Policies, where the sum assured (In case of Death) is less than 10 times the annual premium will no longer be eligible for tax benefits under Section 80C of the Indian Tax Laws.

In other words, if your yearly premium is Rs. 50,000/- the protection cover in case of death must be atleast Rs. 5,00,000/- (5 Lakhs). Otherwise the policy premiums cannot be used for tax exemption under Section 80C.

Almost all Insurance Products (Except Pure Term Plans) will be affected by this ruling. Until this year, the mandated cover was only 5 times the annual premium and Insurance Cos created products that catered to this requirement. Now that the budget has changed this requirement to 10 times, most insurance policies will no longer be eligible for tax benefits.

The Impact will be:

1. We may have to look at availing fresh insurance policies to cover for the existing ones that we can no longer use for tax exemption which means – Additional Expenditure
2. What will we do with the existing policies that are no longer viable tax saving instruments? This will be a dilemma that everyone will have. Should I continue to pay the premium or should I surrender the policy? We will probably cover this as a separate post in future. For now, lets not worry about what to do with those policies.

What will be the Impact on the Insurance Company’s?

Insurance company’s will not have to come up with new products that meet the mandatory requirement of 10 times the annual premium worth of protection. The problem is, all those products that offer less than that, will no longer be useful to customers and hence they wont buy them. One of the primary motivating factors in the sale of insurance products it the tax benefit that comes with it. So, if by purchasing a policy, I wont get tax benefits, why in the hell would I buy it?

The impact will be:

1. Insurance Cos will have to come up with new products
2. There is mandatory approval period for any new policy that a company wishes to propose. IRDA takes some time to review the policy terms and approve it. So, in the meantime policy sales might take a hit
3. Policies that don’t offer this 10 times protection maybe targets for premature surrenders. Customers might choose to surrender their policies before maturity and insurance cos may face issues in meeting the liquidity demand if this number goes up.

Why did the Government Do This?

My Guess – To Prevent People from Using Insurance Policies as Investment

I have always been saying this “DO NOT CONFUSE INSURANCE AND INVESTMENT”

Insurance Cos and Agents have been selling insurance products as investments for decades. The government feels that the primary purpose of Insurance Policies is to provide financial support to the survivors of the insured individual. Any proceeds they get if they outlive the policy is only of secondary importance.

Impact on Various Categories of Insurance Policies

ULIPs and Endowment Plans will be affected as follows:

1. Insurance Cos will be forced to increase the % allocation from the premium amount towards mortality charges (Actual life insurance coverage) to account for the increase from 5 times to 10 times
2. This effectively means that the actual amount available to invest is going to come down (If the same annual premium is to be maintained)
3. If the Insurance co as well as the customer want to maintain the same levels of returns, the annual premium will be significantly higher

Money-Back Plans – These are the plans that in my opinion that will be worst hit. These have effectively been sold as exclusive investment options and they provide very little life insurance coverage. It is possible that the premiums on these policies will go up significantly (much more when compared to ULIPs or Endowment Plans) or such schemes may be scrapped altogether because of the technicalities involved in maintaining 10 times insurance coverage as well as providing good returns on investment.

Pure Term Insurance Plans – These are plans that will have ‘0’ impact due to this ruling. As pure insurance products, they offer a much higher insurance coverage than what is paid as the annual premium. For a premium of Rs. 15,000/- I can get around 30 lacs worth of Insurance. That is nearly 200 times the Annual Premium.


Some Last Words:

If Investment is your primary objective in buying Insurance Policies – then you are better off purchasing investment products like PPF, ELSS etc. With this New Ruling, the returns offered by Insurance policies will come down significantly. As a result, they will start serving their main purpose “Providing Life Insurance”

When Buying a Life Insurance Policy “Focus on life cover, and not on the investment component”

So, personally, I WELCOME THIS MOVE!!!

Do Insurance Policies Really Help Save Tax?

The title is misleading, isnt it? We all know that Insurance Policies help us save tax. You might be wondering, hey Anand, what silly question is this???

Well my dear readers, there is a purpose to this post. Lets take a look at the synopsis of an email I received from one of the readers of my blog a few days back.

Hi Anand,
I had taken a LIC Policy in 2011 in the name of my Minor Brother who is dependent on me. However, the finance department in my office refused to accept the premium paid against the policy for tax deductions under Sec 80C. Can they do that? Please help.

Regards,
Victor

So tell me, was the finance department correct in refusing the premium receipt submitted by Victor on a policy he had taken on his brothers name?

Unfortunately, the Finance Department was correct and Victor mis-understood the Indian Taxation Laws.

Now, go back and read the title again. Does it make sense?

The purpose of this post is to throw some light on the “*Conditions Apply“ aspects of Insurance Policies with respect to the Indian Income Tax Laws.

In my earlier post in “Insurance & Indian Income Tax“ we had taken a look at how Premium paid on insurance policies can provide tax benefits under section 80C. Unfortunately, the whole situation isnt all black and white. There are few catches on the tax benefits you can get from policy premium paid.They are:

1. Name of the Person on whom the Policy is Taken
2. % of Premium Amount that is Eligible for Tax Deduction
3. Mandatory Holding Period

Lets take a look at them one by one in detail.

Name of the Person on whom the Policy is Taken

As per the Indian IT Laws, Premium paid against Life Insurance Policies are eligible for tax deduction only if the policy is registered in the name of:

a. The Tax Assessee (You)
b. Spouse & Children (In case of Married People)
c. Parents (Only if both Mother & Father are Retired/Unemployed/Have No Income)

Premiums Paid in the below cases are not eligible:

a. For a Brother or Sister – Even if they are not earning any income
b. For Parents (If either the mother or the father is still earning)
c. For Uncles, Aunts, In-laws etc

As you can see from the above list, Mr. Victor did not know that premium paid on a policy taken on his Brothers name, eventhough the brother is a Minor and dependent on Victor, he is not eligible to claim tax deductions on that payment.

% of Premium Amount that is Eligible for Tax Deduction

You might be thinking, section 80C has an upper limit of 1 lakh. So, any insurance premium paid upto Rs. 1 lakh is eligible for Tax Deductions. Whats the big deal about it?

Did you really think that?

Unfortunately my friend, its not that simple. The actual premium paid is considered fully for tax exemption (with a higher limit of 1 lakh, of course) only if the amount does not exceed 20% of the Policy’s Sum Assured.

This is something, many of us do not know. In one of my earlier posts, I had written about Insurance Agents mis-selling policies. You may want to be cautious if an Insurance agent tells you something like below:

An Insurance Agent is telling his client that, he has this great One Time Premium policy, wherein if he pays 75000 this year, he will get 2 lakhs at the end of 5 years. Since he can use the full 75000 for tax rebate @ 30% tax rate, he is effectively paying only Rs. 52,500/- and getting 2 lakhs in 5 years. Which is 4 times the money invested.

You must remember that, if the Sum Assured (Maturiy Amount) is 2 lakhs then, the maximum premium you can pay and claim tax rebate in a single financial year is only 20% of it, which is Rs. 40,000/-. The remaining Rs. 35,000/- is not eligible for tax calculation purposes.

Curious Cat Kind of Question:
My Agent tells me that LIC declares a loyalty bonus for all policy holders when the policy matures. So, if i consider a nominal loyalty bonus addition to the policy maturity amount, my premium falls under the 20% slab. Can i claim the whole amount for tax rebate?

Answer: No. The IT Laws do not consider any loyalty bonus or any additional amounts your insurance company could pay you at maturity. Since such amounts are not guaranteed, the IT Laws only consider the policy maturity amount and nothing more.

Mandatory Holding Period

As per the Indian IT Laws, any Tax Payer, who claims tax deductions under Sec 80C using life insurance policies, is expected to pay his/her insurance premium for a minimum period of 2 full years. For a single premium policy if the contract is terminated within two years of the commencement of insurance then the benefit already taken would have to be reversed. The consequence of not fulfilling the holding period is that there is no benefit for the current year for the premium paid and all the previous benefits are reversed with the amounts being considered as income.

For ex: Lets say Mr. Sharma used his premium paid receipts to avail tax benefits in the financial year 2010-11 and for some reason, missed his premium payments in the whole of the year 2011, the IT Department has the right to revoke the tax benefits he claimed in the financial year 2010-11 and ask Mr. Sharma to pay the tax applicable on the deducted amount.

So, if you are someone who is in the habit of forgetting Insurance Payments, do remember that if you miss your payments and the policy lapses, you may end up paying extra taxes on the amounts you claimed tax rebate...

Curious Cat Kind of Question:
For Annual Premium Payment policies, if I pay 2 premiums (2 years) would that suffice?

Answer: No. Since the first premium is paid while taking the policy, you have to pay the annual premium atleast twice (two years) in order to satisfy the mandatory holding period. This means, you must pay a total of 3 premiums, the first while taking the policy and two more in the subsequent two years in order to avail tax benefits.

Since the Jan-March period of the year is considered the “Save Tax“ quarter where people scramble to invest money in tax saving instruments, it would be a nice idea to remember the above mentioned points while taking Insurance Policies that are aimed at saving tax.

Happy Insuring & Tax Saving!!!