Post GST financial sector service tax will
go up from 15% to 18%. The service tax on life insurance plans will also go up which
is likely to affect the insurance sector badly. The new service tax rate will be
18% for term insurance premium and also for ULIP charges. Traditional plans service tax will be 4.50%
(old rate 3.50%) for the first year and 2.25% (old rate 1.75%) for subsequent
years. Hike in service tax is a major blow to small investors. These increases
in service tax will not increase the premium but also will reduce the overall
return in traditional plans.
Traditional insurance plans are sold
heavily historically since LIC came into existence. Previously only LIC was
pushing for these products but now private insurance companies are also
aggressively selling traditional plans. Traditional plans are nothing but
combination of insurance cover and saving element coupled with tax benefit u/s
80-C. Traditional plans are very easy to
sell as they are not complex compared to ULIPs where performance of the fund is
linked market conditions.
We need to agree that insurance
distribution is agents driven. The agents sell only those products where they
earn more commission. Agents are promoting traditional plans heavily only because
traditional plans pay around 35% commission in 1st year and 5% from 2nd year onward as renewal
commission till the premiums are paid.
I strongly feel that the annual returns on
the traditional plans will come down to around 5% p.a. Actually traditional
insurance plans are neither insurance plans as they offer very limited sum
assured against the premium paid nor are they investment products, as they are
unlikely to beat the inflation in long run. It is much better to take a term
plan and invest balance in PPF or Sukanya Samridhi Scheme as both also give tax
benefit and maturity is also tax free like insurance plans. This combination of
term and PPF/SSS will give 2-2.5% more return compare to traditional plans.
Traditional plans are debt oriented plans
as substantial investment of around 85% is done in government and corporate
bonds and 15% is invested in equity. This combination of heavy debt and
defensive equity is like mutual fund’s Monthly Income Plans (MIP) which score better
due to low cost. The MIP Funds invests 15-20% in equity and balance in debt. Despite
MIP fund is not eligible for tax deduction it’s better option as we have seen many
people invest more than Rs. 1.50 lakhs p.a. in life insurance products which
does not qualify for tax rebate. The lack of awareness and advice available in
the market is responsible for this. Every year crores of rupees are spent on
investor education but the result still is not encouraging.
Let us understand the returns difference
with the concrete example. Suppose a 30 year Male wants to buy a traditional
endowment plan of Rs. 10 lakhs sum assured for a 20 year term. The annual
premium for him will be around Rs. 50,000 assuming he is healthy and does not
smoke. The premium for him will be added with service tax applicable. So his
premium for 1st year
will be Rs. 52,250/- And Rs. 51,125/- Second year onwards till end. The bonus
rate for endowment plan is around Rs. 40 per thousand. Assuming this will
remain same till next 20 years the maturity value will be around Rs. 18 lakhs
giving return of 5.11% p.a.
If you invest Rs. 48,000 in PPF after
buying term plan of Rs. 10lakhs the maturity amount will be around Rs. 21.72
lakhs assuming return of around 7.90% p.a. If you invest the same amount in MIP
funds the corpus will be around Rs. 27.50 lakhs assuming return of around
10.00% p.a. PPF and MIP funds will give you more even in case you die within
the term as both corpus in PPF/MIP plus sum assured is payable to the nominee.
The another advantage of term plan is that it will never lapse as the premium
will be Rs. 2,000 p.a. which you still be able to pay in bad days also.
It is difficult to tax foreign entity in
India but easy to pass the burden on common man. It’s not only insurance plans
will cost more but we need to be ready for paying higher charges for banking
services as well. The journey of service tax started from 10% few years back
and it has been increased to 18% now. God only knows when acche din will come
for common people. I strongly feel that service tax on life and health
insurance should be abolished so that people can buy the adequate cover to
secure their family as no support is available from the government.
This article first appeared at indianotes.com
http://www.indianotes.com/Finance-How-to/Service-tax-hike-makes-traditional-plans-unviable/207879/2/T
