Single-premium insurance policies are not tax-efficient. You may not be eligible for tax deduction and the maturity benefits too might get taxed.
A late, leisurely breakfast of aaloo paranthas is a rare treat. So when the strident doorbell interrupted my feast, I was reluctant to greet the guest. Turns out, there were other, more compelling reasons to be unenthusiastic. For on my door was Uncle K. Relatives can be a painful breed, nosy and pesky.
If one of them turns out to be an insurance agent, the pain quotient shoots up. Uncle K has been an agent all his life, and the only time he visits is to sweet talk me into buying yet another policy. He got down to business right away. “You know, I have this new single-premium unit linked insurance plan. As you must be aware, Ulips are investment plans offered by insurance companies with a dash of life cover,” he began between sips of hot tea.
“But why are you recommending this plan?” I interrupted eager to wrap up the conversation and get back to my breakfast. “It’s because you need to invest only once and get a tax deduction for it,” was the pat reply. I took a shot at derision: “Do I?” I asked. It failed. “Of course, you know that the premiums of life insurance policies are tax deductible up to Rs 1 lakh,” Uncle K said.
“The brochure to the policy clearly says that tax benefits as per the prevailing income tax laws,” he added. “Now only if Income Tax Act was as straight forward as that,” I said. “The sub section 3 of Section 80 C of the Income Tax Act 1961 clearly points out that a deduction is available only to so much of the premium, which is not in excess of the 20% of the sum assured [the technical term for the amount of life cover the individual taking the policy opts for] on the policy.
So the entire premium invested in a single premium Ulip cannot be claimed as a deduction against taxable income,” I countered. “Now what was that? You come up with any gibberish and expect to believe you?” Uncle K said. “These days youngsters think they know everything. Listen to me and you can save a neat packet on taxes,” he said. “Obviously, you won't take my word for it.
Let's assume I invest Rs 1 lakh in this single premium Ulip you are so excited about,” I started and instantly regretted the example as Uncle K's face beamed. “You want to invest Rs 1 lakh. That's great,” he interrupted. “It is an example, don't expect me to invest so much and please don’t interrupt me,” I quickly clarified.
“For this premium, my sum assured must be at least Rs 1.1 lakh because the current regulation makes it mandatory for the minimum cover to be to be 110% of the premium for people less than 45 years old. The single premium of Rs 1 lakh works out to be around 91% of the sum assured of Rs 1.1 lakh,” I said, pausing to take a breath. “You are confusing me with so many numbers,” complained Uncle K.
“Hold on, more data is coming up. As I pointed out, according to sub-section 3 of Section 80 C the premium is tax deductible up to a maximum of 20% of the sum assured. For the single-premium Ulip, it will be Rs 22,000 (20% of Rs 1.1 lakh). This is the amount eligible for deduction. I will end up paying tax on the balance premium of Rs 78,000. My income is in the highest tax bracket, so I will have to cough up Rs 24,102 as tax at the rate of 30.9%.”
By now, Uncle K was looking everywhere except at me, trying to come up with some explanation. “I didn’t know all this. I assumed things will be as they always were. Is there any way out?” he asked sheepishly. “Yes, if one opts for a sum assured at least five times the single premium. Going back to the same example, it means opting for a cover of at least Rs 5 lakh. This way, 20% of the sum assured (Rs 5 lakh) is equal to the premium of Rs 1 lakh which will be entirely deductible,” I said with some flourish.
A thoroughly embarrassed Uncle K muttered: “I will keep this is mind.” Aiming to discourage any future conversations on insurance, I added: “There is one more thing. As per Section 10 (10D(c)), the premium should not exceed 20% of the cover in any year of the policy’s tenure. Only then is the entire amount tax-free at maturity. If not, the maturity is added to the income of that year and taxed.”
Uncle K was silent and I reveled in the idea that for once, he had nothing to say. I celebrated a little too soon. “You know so much about life insurance. Why don’t we team up to sell insurance? With your knowledge, we will make a killing,” he said. What did I say about a relative and insurance agent rolled into one?
Single-premium insurance plans are suitable if...
Your income is irregular: Self-employed professionals such as doctors, lawyers, consultants and businessmen have lumpy income. A single-premium plan may be a better option than an annual payment.
You lack financial discipline: A missed premium can cause an insurance policy to lapse. Investors who don’t keep track of their finances may find a single-premium option more convenient than paying the premium every year.
You have got a windfall: If you get a huge amount as inheritance or severance pay and can’t decide how to deploy the funds, it might be useful to buy a single-premium policy. It will not get you tax benefits but at least it will give you insurance cover.