Life Insurance in India is more to do with Tax saving and Investment rather than actual “Insurance”. Budget 2012 has taken cognizance of this fact and has proposed to increase the sum assured limit as a multiple of the premium in order to enjoy tax benefits.
Under section 80C of the Income-tax Act, premiums paid towards a life insurance policy qualify for a tax deduction up to Rs. 1 lakh. But if the amount of premium paid in a financial year for a policy is in excess of 20% of the sum assured, then tax deduction is allowed only on the premium amount up to 20% of the sum assured. As for the benefits, according to section 10 (10D), death benefit in an insurance policy is tax-free, but any other benefit, such as maturity proceeds, is tax-free only if the premium is up to 20% of the sum assured.
The Budget has proposed to reduce this 20% limit to 10%. So to get tax benefit under sections 80C and 10 (10D), you will have to buy a cover at least 10 times the annual premium. Currently, you need to buy only five times the annual premium to enjoy tax benefit.
So for example if you buy a life insurance policy with premium of Rs 20,000 for a Sum Assured of Rs 1,00,000, then it will not qualify for tax exemptions because here premium is 20% of sum assured. However existing policy holders don’t have to worry about this, their policies won’t be affected.
If you are purchasing a term plan, this proposal may not affect you since the sum assured in a term plan is several multiples of the premiums. But if you are buying an investment-cum-insurance policy such as unit-linked insurance plans (ULIP) or traditional plans, this proposal will be of importance.
Presently in ULIPs, if you are below 45 years of age, the minimum sum assured that you can take is 10 times the annual premium in a regular premium payment plan. So in this case, you shouldn’t worry. But if you are above 45 years of age or are buying a single-premium policy, ensure you buy a cover which is at least 10 times the premium.
Most traditional policies are structured to give you tax benefit. However, there are some that do not conform to the tax rules. The proposal has not only increased the protection element but also ensures that insurers are not able to dress sum assured as maturity benefit so that the policies enjoy tax breaks. The Finance Bill has defined the sum assured to mean the minimum amount assured under the policy when the insured event takes place at any time during the term of the policy.
There are some policies in the market which have different death benefit and maturity benefit. Finance Bill 2012 has done away with this discrepancy; now the sum assured will mean the death benefit only.
Further, in order to ensure a minimum death benefit, the bill has proposed that the sum assured that qualifies for tax benefits—in other words it is at least 10 times the premium paid—will be the minimum death benefit that will be paid in any policy year. In other words, if you pay a premium of, say, Rs. 1 lakh, the sum assured will have to be Rs. 10 lakh throughout the tenor. This is in order to check those policies that give a high level of sum assured in year one and subsequently bring down the death benefit.
I think this is a good move and people would get more insurance for the premiums they pay. Also life insurance would cease to be attractive to aged people as the mortality charges for them is higher and a compulsory 10 time sum assured would eat into their returns.
Service Tax Impact on Insurance Plans:
The increase in service tax from 10% to 12% would also affect your premiums as service tax is levied on all forms of insurance. Below are the details:
ULIPs: Last year the budget brought all the cost heads under the service tax net. So instead of being applicable only on mortality and fund management costs, service tax was made applicable on all the cost heads, including the policy allocation charge and policy administration charge. The service tax available on these charges was 10.3%, including cess. From the next fiscal this service will increase to 12.36%
Traditional plans: These plans, which do not disclose costs, the composite rate of service tax has been increased from 1.545% to 3.09% (including cess). This rate is applicable only in the first year; for subsequent years, the rate of service tax has been kept at 1.5%. So you will pay 50% extra service tax for the same sum assured in the first year.
Term plans: Here, a service tax of 12.36% will be applicable on the entire premium since term plans only charges you for the insurance cover.
Non-life plans: In the case of non-life plans such as health insurance or motor insurance, the service tax is levied on the entire premium.