Section 10 (10D) of the Income-Tax Act exempts the money received from a life insurance policy, including bonus, from tax, provided the premium doesn’t exceed 10 per cent of the sum assured. In Finance Act 2021 (starting from February 1, 2021), the government had taken away the tax exemption on unit-linked insurance policies (Ulips) if premium exceeds Rs 2.5 lakh. Budget 2023 has proposed that starting from April 1, income from insurance policies (other than Ulips) whose premium (or aggregate premium for several policies) exceeds Rs 5 lakh in a year will be taxed at the slab rate. Death benefit will remain tax exempt.
“This change has been introduced to prevent high net worth individuals from misusing Section 10 (10D) to earn tax-free returns by investing in high-premium traditional plans,” says Arnav Pandya, founder, Moneyeduschool.
Many products will take a hit
A few years ago, when interest rates were low, non-participating plans of insurers (which promise fixed returns) had become popular. “Since the returns were tax-free at maturity, they offered better post-tax returns than bank FDs and government bonds. Conservative investors who didn’t require liquidity went for them,” says Deepesh Raghaw, founder, PersonalFinancePlan, a Sebi registered investment advisor (RIA).
Many insurance products are structured as retirement products. Says Vishal Dhawan, chief financial planner, Plan Ahead Wealth Advisors, “You invest in them and they make regular payouts later (functioning akin to deferred annuity plans).”
Income from these policies will become taxable from April 1 if their premium exceeds Rs 5 lakh.
In some products, payout happens at two stages: one, at a certain age and the other after death. “Here, the payout during the insured’s lifetime will become taxable while the payout on death will remain tax-free,” says Dhawan.
Some will gain in popularity
Wholelife plans may gain ground. Here the payout will get taxed if the insured is alive at maturity but will be tax-free if received after death. “Insurers companies may keep the maturity age high, say, 100 or 120. If the insured dies before the policy matures, he will receive the payout as death benefit, which will be tax-free,” says Raghaw. He adds that many people may use them to pass on wealth to the next generation.
Annuity plans, the income from which are already taxed at the buyer’s slab rate, will not be affected. “They will remain attractive, provided you buy the right variant at the right age,” says Raghaw.
Some tax planning is possible
The Rs 5 lakh limit is quite high, so many people may not be affected. Moreover, these changes will come into effect from April 1, 2023. Those keen on buying a high-value traditional policy may do so before this date.
Policyholders will have the leeway to do some tax planning. Suppose that a person has five policies whose premiums are Rs 1 lakh, Rs 2.3 lakh, Rs 55,000, Rs 1.8 lakh, and Rs 1.25 lakh. The aggregate premium exceeds Rs 5 lakh. “The policyholder can decide which policies will get the Section 10(10D) benefit and which ones will be subject to taxation,” says Suresh Surana, founder, RSM India. The aggregate premium of those selected for tax benefit must not exceed the Rs 5 lakh ceiling.
Alternative options
Most financial planners don’t recommend traditional plans (see box for their drawbacks). By opting for them, you run the risk that your family may not be adequately insured.
“Investors should rely on a combination of term insurance for protection and mutual funds for investment,” says Joydeep Sen, corporate trainer (debt markets) and author.
Pandya adds that the money saved by buying a term plan should be ploughed into pure investment products (like mutual funds).
In future, investors should build a diversified portfolio (mix of equity and fixed income and gold). Its constituents should be chosen based on investment horizon and risk appetite, and not on whether it offers tax-free returns. For a horizon above seven years, opt for an equity mutual fund; between five and seven years, go for a hybrid fund (like balanced advantage fund). Debt funds belonging to the appropriate category may be chosen by matching the investment horizon with average portfolio duration.
Pros and cons of traditional plans
Pros
When you invest in a non-participating plan, you know in advance the return you will get, provided you or your advisor can calculate the internal rate of return (IRR) accurately
Investors who lack discipline would gain from the forced savings in these plans and the difficulty in exiting
Cons
Sellers often explain the returns in absolute numbers (invest X and you will get Y) and not in terms of IRR
Since these instruments invest largely in debt, returns may not exceed 5-7 per cent
Exiting is difficult: If you exit before paying two premiums, you won’t get any money back; even if you exit later, money will still be deducted from the premiums paid
Older investors get lower returns as a larger portion of the premium goes towards paying the mortality charge