Being a bank relationship manager is not simple to accomplish, especially when you have to fulfil a sales target that is generally multiples of your take-home pay. These bankers are always trying to persuade their customers to invest in a variety of financial products, such as term deposits and mutual funds. Along with these, they like to hard-sell guaranteed insurance policies as well to their customers. This is due to the high commissions offered by insurance companies.
A guaranteed insurance plan is a non-linked, non-participating life insurance savings scheme that provides predetermined benefits while allowing you to tailor your benefits to your specific needs, such as choosing between a fixed lump sum amount or periodic payments after a set period of time or at the time of maturity of the policy, etc. Guaranteed insurance policies account for a greater proportion of the financial products promoted by bank relationship managers. It may be noted that the insurance industry does not keep separate statistics on different policy types that they try to sell through the bank RMs in the public domain.
Commissions vary based on the kind of plan and the insurer, but the commissions are normally between 40-55% of the first year’s premium, which is then reduced in the second year. Insurance is a high commission product, thus insurance firms are pushing bankers to sell it. Bank RMs can accomplish their targets more quickly by selling insurance policies rather than mutual funds. Subscribers do not want to acquire an insurance plan like this, when a large portion of their first year’s premiums are charged as fees or commissions.
Guaranteed insurance plans pay out a predetermined lump sum amount or periodical payments after an agreed upon period of time, or a fixed income until the policyholder’s death, as specified in the policy conditions. Unlike mutual funds, which have fluctuating returns, these insurance schemes provide set payouts. They also provide coverage for life, which is generally 10 times the annual price paid. It should also be noted that mutual funds allow investors to redeem their investments at any time by incurring the necessary capital gains tax and exit cost. For guaranteed insurance policies, the money remains locked in until maturity.
The other disadvantage of these guaranteed plans is that if you cancel the plan before its term expires, the refund you receive will be quite low in comparison to the premium amount paid.
Tax benefits:
One tax break that customers receive is that premiums paid for life insurance plans are deductible under Section 80C of the Income Tax Act. This tax benefit is anyways available for premiums paid on any insurance plan issued by an insurer licensed by the Insurance Regulatory and Development Authority of India (IRDAI). However, one reason why guaranteed insurance plans are popular among investors is the tax-friendly nature of their maturity advantages, which make them more appealing than the debt mutual funds and other government securities such as sovereign bonds.
In one such guaranteed insurance scheme, if you spend one lakh every year for ten years and then wait another ten years, you will receive a lump amount of 22.72 lakh at the end of twenty years. This represents a 5.3% tax-free internal rate of return (IRR). However, if you put a comparable amount in a debt mutual fund for 20 years, the IRR is 6.7%. After tax deductions and assuming a 30% income tax bracket, the IRR drops to 4.4% for the debt mutual fund. Hence, these guaranteed tax-free insurance plans provide higher returns compared to various debt mutual funds. Other fixed-income products, such as bonds and fixed deposits, would be subject to the same tax treatment as debt mutual funds, which make these guaranteed insurance plans more appealing when compared to investments in debt. But we need to note that GST (Goods and Services Tax) as a service charge marginally affects the effective IRR of these insurance plans, making the benefits of these plans closer to debt mutual funds or bonds. It should be noted that the first year’s goods and service tax is 4.5%, followed by 2.25% thereafter. Also, if the policyholder discontinues paying the premiums within two years or cancels the insurance, the previous tax deductions are recovered from the policyholder.
Premiums paid in guaranteed annuity plans of up to 5 lakh are tax-free at maturity. However, there are no tax advantages if the premium paid for any policy or policies taken together in a year exceeds Rs. 5 lakh. To clarify this, it may be noted that income or maturity benefits obtained from insurance policies issued on or after April 1, 2023 (except unit-linked policies) with a premium or aggregate premium above Rs. 5 lakh per year will be taxed (with the exception of in the event of the insured’s death).
People can also purchase these insurance in the names of their spouses or children to claim tax breaks on the premiums paid. Thus, a family of four can spend a total of 20 lakh in such guaranteed insurance plans, with no tax imposed at plan maturity.
To qualify for tax rebates on the maturity amount, the sum insured must be at least ten times the yearly premium paid. Furthermore, if the premium paid in any one year exceeds 10% of the total insured, the maturity proceeds will be taxed. If the insurance policy is not tax-exempt, the difference between the premium and the maturity amount is subject to a 5% tax deduction at the source (TDS). For example, suppose you paid a premium of 2 lakh over a ten-year period and earned 5 lakh at maturity. In this situation, the insurance company deducts a 5% TDS on Rs. 3 lakh (the maturity amount less your investment).
When the maturity amount is reflected on their income tax statement, the policyholder may be required to pay more tax, depending on their income. The 5% TDS is mostly for registering these insurance transactions. If the beneficiary is above the age of 80 and the sum received is less than three lakh rupees, the individual may be eligible for a refund of the tax deducted. In contrast, earning professionals or businesspeople may face greater taxes, if their tax bracket is more.
There is no clear income tax law governing how the proceeds from the insurance maturity amount should be treated for tax purposes. A frequently asked question is whether it should be regarded as income from other sources, which is taxed at the slab rate, or as capital gains. The only certainty at the time of writing this blog-post is that if the insurance payouts are distributed in the event of the policyholder’s death, no taxes will be due.
Final word on this:
The tax deduction makes insurance appealing, but the commissions are frightening, cutting into your effective profits that you could receive by investing in less commission-driven instruments.
Investors generally prefer keeping their money for 10-15 years to get around more returns, at least more than the 6% return given by these insurance schemes. Equities have the potential to provide double-digit returns (about 10-14%). So, even if you pay a 10% tax on stocks, the returns can range from 9% to 13%, which is an appealing prospect.
Taxation should be considered when purchasing a product, but it should not be the sole determining factor. People should also consider asset allocation, and the investment products they buy or invest in should meet their and their family’s financial needs, rather than simply saving money on taxes.
