You purchased a pension plan many years back. The plan is about to mature.
You get a call from the insurance agent/salesperson that you can use the pension plan proceeds to purchase a Unit Linked Insurance plan. What will you do?
I have received quite a few similar queries over the last few months. Perhaps, this always used to happen. Just that I got aware because of the queries I have been getting from the readers.
How does this work?
You have a pension plan which is about to mature.
As per the extant rules, you can take 1/3rd of the accumulated corpus as lump sum. This amount will also be exempt from tax.
For the remaining 2/3rd portion, you will have to purchase an annuity plan. Annuity income is taxable in the year of receipt at your marginal income tax rate.
What Insurance agent tells you?
If you use this pension plan to purchase an annuity plan, you will have to pay tax on the annuity income. Moreover, annuity rates are quite low.
And they have a better offer.
Use the amount to purchase a Unit linked insurance plan (ULIP). And you can withdraw the amount after 5 years tax-free.
Sounds good, doesn’t it?
You avoid a low return annuity product and the taxes on such annuity income. Brilliant!!!
Where is the catch?
There has to be a catch. Things are never so rosy.
Firstly, pension plans are pension plans for a reason. The purpose is to provide pension.
As per IRDA rules, 2/3rd of the accumulated wealth at the time of maturity needs to be used to purchase an annuity plan or a deferred pension product. There is no exception (except for NPS).
So, how can you use 2/3rd corpus or the entire corpus to purchase a ULIP?
Clearly, you can’t.
How then are the insurance agents asking you to purchase a ULIP?
This is what they are hiding from you.
Essentially, they are asking you to surrender the pension plan. If you surrender the plan, there is no compulsion to purchase an annuity plan.
Were you told that you will have to surrender your pension plan if you want to go by their chosen method?
I am quite sure you weren’t.
Surrendering a pension plan has its own set of problems
There might be surrender costs involved.
Additionally, the surrender proceeds of a pension plan are taxable at your marginal income tax rate.
Some tax experts argue that the entire surrender proceeds are taxable only if you took the tax benefit under Section 80CCC for the investment in this pension plan. Fair enough.
Since I am not a tax expert, I won’t argue on this aspect.
However, even in this best-case scenario where you didn’t take any tax benefits for investment, the proceeds are not entirely exempt from tax. Either the proceeds will be taxed as income from other sources (with a deduction for premiums paid) or the proceeds may be taxed as capital gains.
However, does the insurance agent know whether you took any tax benefit for this investment in the pension plan? I doubt you were asked about this. More importantly, does he even care?
What if he is merely concerned about a fresh insurance product sale, meeting sales targets and earning sales incentives (or commissions)?
Where is your interest?
If you have been made such an offer, do understand the nitty-gritty of your product.
Don’t just go by the words of the salesmen.
Do note I am not saying you must not surrender your pension plans. If you have purchased a poor product, it is better to get out as soon as possible.
However, in these specific cases, the policy is about to mature. So, you have already taken the hit. In such cases, it may be a good idea to continue until maturity.
The key lies in being aware of the regulations and your policy wordings.
Make an informed decision.
It is possible that they might ask you to purchase another deferred pension product or a ULPP (Unit Linked Pension plan), in which you do not need to surrender the existing plan. However, in this case too, you will face a similar problem when this new product is about to mature (you are essentially deferring tax and incurring costs).