Tax-saving season is underway. You must already be exploring ways to save income tax under Section 80C of the Income Tax Act. And when the discussion on tax-saving products is on, life insurance plans will invariably come up. After all, the premium paid to keep life insurance plans in force is eligible for tax benefits under Section 80C of the Income Tax Act.
Life Insurance Plans come in many variants i.e. term life plans, traditional plans and unit linked insurance plans (ULIPs). Even these variants come in multiple sub-variants. One of the classifications is based on the frequency of premium payment. On the basis of frequency of premium payment, these plans can be classified in to single premium, regular premium and limited premium payment plans.
Under single premium plans, you pay premium just once. Under regular premium payment plans, the premium payment term is same as term of the life cover. Under limited payment term plan, the premium payment term is less than the term of the life cover.
In this post, I will discuss Single Premium Payment plans in detail. I will also discuss pertinent income tax rules that might influence your decision to purchase such plans.
What are Single Premium Life Insurance Plans?
As the name suggests, under single premium insurance plans, you pay premium just once and get the life cover (and investment benefits, if any) for many years.
So, you pay the premium just once and enjoy life cover for many years.
Unit linked insurance plans (ULIPs), traditional life insurance plans and even term life plans can come in single premium variants.
Everything else is same in Single Premium Plans as compared to regular and limited premium payment life insurance plans.
Advantages of Single Premium Life Insurance Plans
You don’t have to pay premium every year. So, the policy cannot lapse due to non-payment of premium. Drawing parallel from a popular Hero Honda Campaign for good mileage, Single Premium plans are “Fill it, Shut it , Forget it” insurance plans.
However, if you are disciplined with your premium payments, I wouldn’t worry about this issue.
In my opinion, there is nothing special about these plans.
Some argue that the single premium plans are good places to park lump sum funds. I don’t subscribe to this opinion. There are many better and simpler options available.
If you see single premium insurance are at the end ULIPs, traditional plans or term life plans only. So, the issues I have highlighted with ULIPs and traditional life insurance plans in many of my previous posts still remain. Just the fact that you have to pay premium just once does not change that.
In fact, Single premium plans, due to their nature, face a significant tax problem. Let’s see what these tax issues are.
Income Tax Rules for Life Insurance Plans
As per Section 80C of the Income Tax Act, for the life insurance policies issued on or after April 1, 2012, the maximum tax deduction is capped at 10% of the Sum Assured.
An additional relaxation of 5% (i.e. up to 15% of Sum Assured) is available to person suffering from disability or severe disability (as specified under Section 80 U) or to those suffering from a disease or ailment as specified under Section 80DDB. Under a life insurance policy, Sum Assured is the minimum amount assured to the nominee in the event of death of the policy holder.
Hence, if you purchased a single premium plan with Sum Assured of Rs 10 lacs with one-time premium of Rs 5.17 lacs. In this case, you will get tax benefit for only Rs 1 lac (10% of Sum Assured) under Section 80C of the Income Tax Act.
You might be ok with tax deduction. After all, the maximum allowable deduction under Section 80C is Rs 1.5 lacs. Remaining Rs 50,000 will be covered through your EPF or home loan principal repayment or any other 80C investment.
The bigger issue is with the maturity amount. If the premium paid does not meet the above criterion (Life Insurance Premium <= 10% of Sum Assured), the maturity proceeds are not exempt from tax as per Section 10 (10D) of the Income Tax Act. In other words, if the Sum Assured is less than 10 times the premium (annual or one-time), the maturity proceeds are not exempt from income tax. There will be some relaxation (as mentioned earlier) if your case falls under Section 80U or 80DDB.
The only exception is in case of demise of the policy holder during the policy term. Proceeds from life insurance plan arising due to death of the policy holder are exempt from tax irrespective of the level of premium.
The maturity proceeds will be added to your income during the year and taxed as per income tax slab. For those who were under the impression that maturity proceeds of all life insurance policies are exempt from tax, this might come as a shock.
How does this tax rule affect Single Premium Life Insurance Plans?
This is a double whammy for single premium life insurance plans.
Owing to the nature of single premium plans, you can expect the premium for such plans to be reasonably high. It is quite likely that you won’t be able to meet the condition (Sum Assured at least 10 times premium). Hence, the maturity proceeds will not be exempt from tax.
Not only do you get lesser tax benefits (under Section 80C) but the entire maturity proceeds are taxable.
Let’s consider an illustration. I have considered a term plan, a ULIP and a traditional plan for a 30 year old.
You can see term life plans are still safe. Firstly, Sum Assured is even now a higher multiple of single Premium. Secondly, there is no maturity value attached with term life plans. Hence, there is no question of taxing maturity proceeds.
But single premium traditional plans and ULIPs have problems. Tax benefit under Section 80C will be limited to Rs 1 lac in the two cases. Maturity proceeds from the aforesaid traditional plan and ULIP won’t be exempt from tax.
IRDA regulations for Single Premium Products
As per IRDA Linked Insurance Products Regulations, 2013, for a single premium ULIP, the Sum Assured shall be at least 1.25 times the single premium (age < 45 years). For age equal to or greater than 45 years, the minimum Sum Assured is only 110% of Sum Assured.
You can see minimum Sum Assured can be as low as 1.1 times the Single Premium.
For the maturity value to be exempt from income tax, Sum Assured needs to be at least 10 times single premium.
In case of ULIPs, the commission to the intermediary (agent) is capped at 2% of the single premium as per aforesaid IRDA regulations. This is a positive point about single premium insurance products. The commissions for non-single premium insurance plans (regular premium plans) are much higher. Here is another example of mis-selling where a two year premium payment plan was sold to customers (instead of a single premium plan) just to earn higher commission. Single Premium Payment plan was cheaper.
For traditional life insurance plans, the minimum Sum Assured and the commission structure is similar to those of ULIPs (IRDA Non-Linked Products Regulations, 2013).
Cases of Mis-selling: Single Premium Plans are not for the elderly
Many a times, single premium plans (especially single premium ULIPs) are pitched as fixed deposits which offer returns better than a fixed deposit, offer tax benefits and provide life insurance too. This is especially true when the equity markets are on the uptrend. Just like fixed deposits, you have to invest just once. A number of people fall for the trap.
You will be told that the maturity proceeds will be exempt from tax. Either the agents are themselves not aware or are just playing too smart. But now, you know the truth.
Why does it happen? Simple. Commissions. As mentioned before, commissions for the single premium plans can go to as high as 2% of the premium. On a premium of Rs 8 lacs, the agent or any other intermediary can net as high as Rs 16,000.
Since a number of us visit bank branches for opening fixed deposits, beware of bank officials. Even they sell such insurance plans.
Retired citizens (senior citizens) don’t really need life insurance (well, most of them). The earning phase of their lives is already over. In any insurance and investment combo product, a part of premium goes towards mortality charges (for life cover) and the remaining is invested.
Mortality charges go up with age. So, the older you are, greater the mortality charges and less the amount left for investment. Add to this agent commissions and various other types of charges. If you are purchasing such plans, be prepared for low returns.
No better example than this retired person whose Rs 50,000 turned to Rs 248 in five years. For more details, read this Mint story: How to shrink Rs 50,000 to Rs 248?
You must keep your insurance and investment needs separate. I have said this many times before.
Term life insurance plan is the best form of life insurance. Based on your family structure, you can also opt for Income Replacement Term Life Plans.
Traditional life insurance plans are toxic and must be avoided at any costs.
Unit Linked Insurance Plans are a much improved lot (over ULIPs of the past decade). However, I prefer a combination of term life plan and mutual funds over ULIPs.
Be aware of the income tax rules if you plan to invest in insurance products (with investment benefit). Maturity proceeds of single premium plans will most likely be taxed.
Stay away from single premium life insurance plans (unless you are purchasing a single premium term life plan).
Image Credit: Moolanomy, 2012. Original Image and information about usage rights can be downloaded from Flickr.com