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Life insurance policies which for long have been bought as a savings & investment instrument and a tax-saving tool may now be back to its original avatar. The amendments in Budget 2012-13 send out a single message – avail life insurance policies for pure risk cover.
The budget proposal has brought in some change that will affect the insurance industry and policyholders. First, all regular premium life insurance policies will be eligible to vbe exempted from income tax each year (under section 80C) only if the Basic Sum Assured is at least 10 times the Annual Premium. The same ratio of Premium: Sum Assured of 1:10 needs to be maintained even for a tax exemption of Maturity Benefit under section 10(10) D as well. This will be applicable for all policies issued on or after 1st Apr 2012.
The definition of sum assured also witnessed more clarity whereby the computation of sum assured for claiming deduction shall include premiums that will be returned to the policyholder excluding the bonuses. To emphasize this point, the fine print in Budget of 2012-13 states, “This amendment has been proposed to ensure that the life insurance products are not designed to circumvent the prescribed limits by varying the capital sum assured from year to year”
What is 80C an 10(10)D Benefit?
Life Insurance Premium paid till Rs. 1 lac annually can be eligible for a Tax Rebate under section 80C of the Income Tax Act. However, the maturity proceeds from a Life Insurance Policy qualifies for Tax Rebate under section 10(10)D of the Income Tax Act.
What does it actually mean?
Presently the rule is that the Annual Premium needs to be below 20% of the basic Sum Assured for an exemption under 80C for a Life Insurance Policy, i.e. the Sum Assured needs to be only 5 times the Annual Premium. Now, the Sum Assured has to be 10 times the Annual Premium for a tax rebate. This rule however is not applicable to Pension Plans.
So for example if you buy a regular premium Life Insurance Policy with annual premium of Rs 20,000 and a Sum Assured of Rs 1,00,000, then it will not qualify for tax exemptions. The minimum Sum Assured for an Annual Premium of Rs 20,000 has to be Rs 2,00,000 for it to qualify for tax exemption under 80C.
This rule however is applicable for policies purchased post 1st April 2012 and existing policy holders need not worry as their policies will not be affected.
How does it affect the Policyholders?
This rule applies to all regular premium Life Insurance policies, which includes Term Plans, Unit Linked Insurance Policies (ULIPs) as well as Endowment Plan. Both ULIPs and endowment plans will be affected due to this change. However, most Term Plans are already within the purview of the new requirement.
Now, since it is mandatory to maintain the sum assured, a bigger part of the premium will be allocated towards Mortality Charges. Mortality Charge is the amount charged every year by the insurer to provide the life cover to the policyholder. It can otherwise be called the Cost of Insurance.
Once the amount of premium contributed towards mortality charges (insurance cover) increases, the amount left for the investment purpose will go down. Simply put, a person who is looking at insurance policy as merely a savings tool may not find it attractive to buy a Life Insurance Policy anymore. The person may however, choose to invest in other tax saving instruments like Public Provident Fund, ELSS, National Savings Certificates, equity and mutual funds. Very clearly, the government is highlighting the dire need for increasing risk cover among Indians and therefore pushing buyers to avail more of pure term plans than unit-linked or endowment plans.