For a large section of investors, insurance and the month of March are synonymous. Since insurance policies allotted before the financial year (March) ends are eligible for tax rebates that is the time when most investors decide to get themselves 'insured.'
The crux of the matter is that insurance is seen as a tax saving device. Is this the appropriate way to assess an insurance policy? We think not.
Life insurance means indemnifying the risk of death and compensating for the financial loss caused to the survivors. The prime objective of any insurance policy should be to 'insure.' Tax benefits should not be the driving force for an insurance policy.
Insurance policies are designed to meet a wide variety of needs ranging from savings to profits. What an investor needs to do is pick and choose the one that best suits his profile. Broadly speaking insurance policies can be categorised as follows.
Pure risk cover
Policies in this category like term assurance plans appeal to investors who primarily need only a risk cover. The policy holder makes premium payments during the term and chooses the lump sum amount payable to nominees in case of the policy holder's death. No benefits are payable on survival at the end of policy term.
Whole life policies, wherein the policy holder pays a fixed premium (based on his age and other factors) during his entire lifetime and the nominees are paid a fixed benefit on his death also qualify as pure risk covers.
Return oriented cover
Insurance policies which combine returns and risk cover i.e. Endowment and Money-back policies fall under this category. Endowment policies involve payments of a lump-sum amount either on death or on maturity. The lump-sum is the basic sum assured plus bonus additions. Endowment plans are used to provide for children's education, marriage, etc.
Money-back policies are similar to Endowment policies, however they differ as regards the outflows are concerned. A part of the sum assured is paid to the policy holder before maturity. Single premium policies and Child plans also feature as popular choices for return oriented policies.
Pension plans
Pension plans are tools for retirement planning. Policyholders make contributions over a period of time (or a one-time contribution) to form a corpus. This corpus is used to generate regular income for policy holders from the retirement age.
The pension plans are flexible whereby income can be received either for a fixed tenure or till death. Some pension plans have the option whereby survivors are paid a lump sum amount on the policy holder's death.
From the listing above it is fairly obvious that the investor has a wide variety of choices at his disposal. It is only a matter of making the right choice. For someone who is in the 30s and is planning for his/her children's education 20 years hence, a child-plan would be the appropriate choice, similarly term assurance is like to be the apt choice for a sole earning member in his mid-forties.
Tax benefits continue to be major crowd pullers for insurance schemes. Investors can avail of tax rebates under section 88 in the range of 15 per cent to 30 per cent of the premium paid during the year depending on the total income.
Income levels & Tax rebates under Section 88
| Income per annum | Tax rebate |
| Between Rs 50,001 to Rs 150,000 | 20% |
| Between Rs 150,001 to Rs 500,000 | 15% |
| Above Rs 500,000 | NIL |
Apart from the rebates listed above assesses whose gross salary income does not exceed Rs. 100,000 and salary chargeable to tax is less than 90 per cent of the gross total income can claim a rebate of 30 per cent of premium paid.
However commencing April 1, 2003, i.e. relating to assessment year 2004-05, exemptions will be denied in any year if the premium paid exceeds 20 per cent of the sum assured. This provision will adversely affect investors in single premium policies.
Section 10(10D) provides that maturity proceeds (either claims or at the term end) of insurance policies including bonus are entirely tax-free. Again single premium policies are exceptions whereby the proceeds on maturity cannot avail of any tax benefits. The profits from such policies will be charged as capital gains tax.
Contributions to pension schemes don't qualify for rebate under section 88. However, contribution to pension funds is deductible under section 80CCC from the gross total income to the extent of the amount paid or Rs. 10,000, whichever is lower.
Pension schemes differ from insurance products as far as taxability of returns is concerned. The proceeds from the scheme are fully taxable as "income from other sources".
Section 80D also offers tax benefits when medical riders are added to the policy up to an amount of Rs 10,000. Put simply riders are additional benefits which can be added to the policy to enhance the insurance value. Critical illness riders are commonly added to avail of the tax benefit.
Tax rebates at a glance
| Section under Income Tax Act | Particulars |
| Section 88 | 0% to 30% depending on the tax bracket |
| Section 80D | Medical benefit premium up to Rs 10,000 deductible from taxable income |
| Section 80 CCC | Pension benefit premium unto Rs 10,000 deductible from taxable income |
| Section 10 (10D) | Amounts received from Insurance company in form of claim |
| or maturity benefits along with bonus is entirely tax free |
The returns offered by policies are closely linked to the premiums paid, so are the tax benefits. One might be led to believe that choosing a policy with a higher premium is always the right choice. However in most cases the premium will have to be paid at regular intervals over a period of time.
Defaults in premium payments can lead to the policy being terminated and consequential loss of protection cover. Also the surrender value of a lapsed policy in most cases is only a fraction of the premiums paid.
This brings to our original discussion i.e. your needs should be the deciding criterion for the insurance policy not tax benefits. The gap between your present and desired status should help you decide the policy which suits you the best. The attractive tax benefits should be seen as perks offered by the insurance policy.
Focus on the "insurance" part of your policy; it will make sense in the future.
This article forms a part of Money Simplified -- Asset Allocation for Tax Saving Instruments, a free-to-download online guide from Personalfn. To download the entire guide, click here.