Among the few changes to the rules governing our money matters announced in the Union Budget for 2023-24, Finance Minister Nirmala Sitharaman decided to tax high-ticket life insurance purchases. To be precise, she proposed to tax maturity proceeds of all life insurance policies (other than Unit-Linked Insurance Plans or ULIPs) bought after March 31, 2023, where the annual premium exceeds Rs 5 lakhs.
Prior to this announcement, a buyer could claim tax exemption on income from such policies. However, the new rule of removing tax exemption for high-value policies will not apply if they are purchased up to March 31. Also, proceeds from all death claims of life insurance policies irrespective of date of purchase of life insurance policy and irrespective of the amount of premium paid remains tax-free in the hands of the nominees (or legal heirs) of the deceased life assured.
Before we get into the implications of this new rule, let's look back a little to provide context to this move. While presenting budget 2021, Sitharaman had removed the tax exemption of maturity proceeds of all those ULIPs wherein the annual premium exceeds Rs 2.5 lakhs. Also, the finance minister decided to make interest taxable for annual contribution in excess of Rs 2.5 lakhs towards the Employees' Provident Fund (EPF). By doing so, the government has indicated that it intends to cap the tax-exemption available to the general public. However, exemption remains for maturity proceeds under section 10(10D) and is available for all those policies where the premium paid is less than 10% of the sum assured.
Now, let us come back to the present. While presenting Budget 2023, the Finance Minister decided to cap the benefits for traditional life insurance policies. Sales of traditional life insurance policies, including endowment policies and money-back policies, have been rising for some time now. Interest rates have gone up and the life insurers are busy packaging the life insurance products offering a 'tax-free' return of around 5-6% on these over the next couple of decades, along with insurance cover. Many high net worth individuals (HNIs) who want to keep some money out of their business and do not want exposure to volatile financial markets, are grabbing these products to lock in the current yields. As an icing on the cake, they were also eligible for tax exemption on the income. The finance minister saw this loophole and decided to plug it.
It is evident that the market has been aware that life insurers have been making good money selling these policies. No wonder, stocks of listed life insurance companies fell 8-10% immediately after the announcement to tax proceeds on high-value life policies.
Other than the revenue implications, the decision to tax high-value insurance policies throws up a few timeless lessons life insurance buyers.
First, life insurance and investment are two different things and need to be looked as such by buyers. Just because the proceeds of life insurance policies have been tax-free, one should not mingle the two. In case of most traditional plans, the yields are around 4-6% and many buyers queue up to buy these policies. They tend to forget that if they have a long enough view and are willing to invest a fixed sum each year as they do with their life insurance policies, then the equity markets could be a far better place to invest and pocket better returns.
Most experts estimate around 10-12% average annual returns on professionally managed equity portfolios (read mutual funds or portfolio management services) over the long term. If you are keen on returns, it is better to go to investment products. For your life insurance and protection needs for your loved ones when you are not around, a term life policy with lower premium and high insurance cover could be the best bet.
The second lesson is that tax-planning should be incidental to the financial planning targeted at achieving your financial goals and not the primary driver. Many times, to save on tax, people end up buying random financial products, including life insurance policies. As March 31 nears, you are sure to hear pitches from all insurance companies and their agents to buy high-value policies to best the deadline and save tax. Do not fall for that. Let your financial goals dictate your insurance purchase.
Amid all this, do not forget to widen your insurance coverage. Yes, you read it right. Building an insurance portfolio does not require big premium payments. You should use your insurance budget wisely -- assess your life insurance needs. Purchase pure term life insurance policies and supplement it with other rider benefits such as accident disability cover, critical illness cover that come with the base term policy. In most cases there is a limit of the benefit offered under such riders attached to life insurance policies. In that case, you are better off purchasing standalone cover to enhance these covers.
Purchasing health insurance for self and family in personal capacity helps, even if the employer may be offering health insurance. These also bring in some tax-relief. Personal accident insurance plans, home (property) insurance and auto insurance are some covers which do not offer tax benefits but ensure peace of mind.
(Sarbajeet K Sen is a senior financial journalist.)