Service tax hike makes life insurance plans unviable
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The service tax on life insurance plans will go up w.e.f. 1st June 2015. The new service tax rate will be 14% (old rate – 12.36%) for term insurance and for traditional plans it will be 3.50% (old rate 3%) for the first year and 1.75% (old rate 1.50%) for subsequent years. These increases in service tax will increase the premium and also surely reduce the overall return in the traditional plans. Traditional plans are a combination of insurance cover and saving element coupled with tax benefit. The entire debate after Modi government completed one year was around growth and development but nobody noticed that this minor change can affect the crores of policy holders. Hike in service tax is a major blow to common man as it will not only increase their insurance premium but also increase mobile bills other services.
Traditional insurance plans are sold heavily historically since LIC came into existence. Previously only LIC was pushing for these products but now private insurance companies have also aggressively launched many traditional plans in last few years. Traditional plans are very easy to sell as they are not complex as compare to ULIPs. The traditional insurance plans neither are insurance plans in proper meaning of the term as they offer very limited sum assured against the premium paid nor are they investment products, as they are unlikely to beat the inflation.
We need to agree that insurance distribution is agents driven. The agents sell only those products where they earn more commission. Agents are promoting traditional plans heavily because traditional plans pay around 35% commission in the 1st year and 5% renewal commission thereafter till the premiums are paid. IRDA is silent and not taking any steps to reduce charges in traditional plans. This hidden charges and increasing service tax will surely make traditional life insurance plans investor unfriendly.
The service tax journey started from 1% and has now increased to 3.50% in just 4 years time. Now June onwards you have to pay more premiums because of the hike in service tax. I strongly feel that the annual returns on the traditional plans will come down to below 6% p.a. It is much better to take a term plan and invest balance in PPF as PPF also gives tax benefit and maturity is also tax free. This combination of term and PPF will give at least 2% more return compare to traditional plans.
The other option for investment can be conservative MIP Funds as many people invest more than Rs. 1.50 lakhs p.a. in life insurance products. Traditional plans are debt oriented plans as substantial investment of around 85% is done in government and corporate bonds and only 15% is invested in equity. This combination of heavy debt and defensive equity is like mutual fund’s Monthly Income Plans (MIP) which score better due to low cost. You can expect around 10% average tax free return from MIP plans of mutual funds. The lack of awareness and advice available in the market is responsible for this. Every year crores of rupees are spent on investor education but the result still is not encouraging.
Let us understand the returns difference with the concrete example. Suppose a 30 year Male wants to buy a traditional endowment plan of Rs. 10 lakhs sum assured for a 20 year term. The annual premium for him will be around Rs. 50,000 assuming he is healthy and does not smoke. The premium for him will be added with service tax applicable. So his premium for 1st year will be Rs. 51,750/- And Rs. 50,875/- Second year onwards till end. The bonus rate for endowment plan is around Rs. 45 per thousand. Assuming this will remain same till next 20 years the maturity value will be around Rs. 19 lakhs giving return of 5.62% p.a.
If you invest Rs. 48,000 in PPF after buying term plan of Rs. 10lakhs the maturity amount will be around Rs. 22 lakhs assuming return of around 8.00% p.a. If you invest the same amount in MIP funds the corpus will be around Rs. 27.50 lakhs assuming return of around 10.00% p.a. PPF and MIP funds will give you more even in case you die within the term. The another advantage of term plan is that it will never lapse as the premium will be around Rs. 2,000 p.a. which you still be able to pay in bad days.
It is difficult to tax foreign entity in India and easy to pass the burden to common man. The Finance minister has abolished the Wealth Tax and did not hesitate to increase the service tax which affects the common man. Cover offered under Pradhan Mantri Yojana of Rs. 2 lakhs both life and accidental death is inadequate for all middle class family. I strongly feel that service tax on life and health insurance should be abolished so that people can buy the adequate cover to secure their family.
The author is a CERTIFIED FINANCIAL PLANNER by Profession. He is preparing comprehensive financial plans for the Clients. He holds Bachelor Degree in Commerce and Law. He is also IRDA and AMFI Certified. He has over 12 years of rich experience in the field of Financial Services with special expertise in Life Insurance, Loans and Mutual Fund products.
The author can be contacted at [email protected]
Disclaimer: The author has taken due care and caution to compile and analyse the data. The opinions expressed above are only the views of the author, and not a recommendation to buy or sell. The author does not accept any liability whatsoever arising from the use of any of the above contents.
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