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.