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Why many bankers hard-sell guaranteed insurance plans

Guaranteed insurance plans are tax free and therefore yield more returns  than most debt mutual funds.
Guaranteed insurance plans are tax free and therefore yield more returns than most debt mutual funds.

Summary

  • While they earn hefty commissions on these products, investors benefit from the tax sops.

Being a bank relationship manager is not easy, especially if one has to meet a sales target that is typically in multiples of the take-home salary. These bankers have the unenvious job of convincing their high net-worth clients to invest in various financial instruments, including fixed deposits and mutual funds. However, they prefer to hard-sell guaranteed insurance plans, according to industry executives. And that is because of the huge commissions dangled by the insurance sector.

Industry executives aver that guaranteed insurance plans make up for a bigger chunk of the financial instruments marketed by relationship managers. To be sure, the insurance sector does not segregate data on different types of policies in public domain. The head of a leading bank’s private wealth division told Mint, on condition of anonymity, that about half of the firm’s total assets under management (AUM) are deployed in guaranteed insurance plans.

The commissions vary depending on the type of plan and the insurer but are typically around 40-55% of the first year premium and subsequently lowered from the second year onwards. In March, the insurance regulator removed a cap on product-specific commissions. It said the commissions will now be covered under an insurer’s expense of management.

“Insurance is a high commission product and they (the insurers) are incentivizing the bankers to sell it. We don’t subscribe to half the AUM going into a product like this. This can just form a part of one’s fixed income portfolio but if the horizon is 10 to 15 years, they can have more allocation to equity products," said Himanshu Kohli, co-founder of Client Associates, a private wealth management firm.

Equity products also offer better returns but with higher risk. For instance, the rolling returns from Nippon Bees (Nifty ETF) was 11.74% during a 10-year period. Note that in the case of mutual funds, the investment can be redeemed at any time by paying the applicable capital gains tax and exit load. For guaranteed insurance products, this money gets locked in until maturity.

Nithin Balachandani, who runs Insurance Angels, said that if you discontinue the plan before its term ends, its surrender value would be very nominal compared to the premium amount paid.

Guaranteed insurance plans pay out a fixed lump sum amount or regular payments after a specific period, as defined in the policy documents. Unlike mutual funds, whose returns are variable, these plans offer fixed payments. They also come with a life cover which is typically 10 times the annual premium paid.

Currently, there are various insurance products in the market such as money back plans, guaranteed plans, or endowment plans. These plans come with an annual premium which has to be paid for a few years before the policyholder receives a fixed income every year after a specified period. Some plans fetch a fixed income after the policy term ends. Others offer a fixed lump sum on maturity or a fixed income until the death of the policyholder.

 

(Graphic: Mint)
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(Graphic: Mint)

Tax breaks

One reason why guaranteed insurance plans find favour with investors is their tax-friendly nature, which makes them more attractive than debt mutual funds and government securities.

Under one such insurance plan, if you invest 1 lakh annually for 10 years and then wait for another 10 years, you will get a lump sum of 22.72 lakh at the end of 20 years. That’s a tax-free internal rate of return (IRR) of 5.3%. However, if you were to invest a similar amount in a debt mutual fund over 20 years, the IRR comes to 6.7%. Post tax deductions, considering a 30% income tax slab, the IRR falls to 4.4%. Thereby, these guaranteed tax-free plans yield more returns than most debt mutual funds. A similar tax treatment as that of debt MFs would apply to other fixed-income products like bonds and fixed deposits.

To be sure, premiums paid up to 5 lakh in guaranteed annuity plans are exempt from taxation at the time of maturity. Last year’s budget introduced a provision that denies tax breaks in case the premium paid for any policy or policies taken together in a year exceeds 5 lakh.

People can also buy these policies in the names of their spouse or children to claim tax benefits on the premium paid. Thus, for a family of four members, a total of 20 lakh can be invested in such guaranteed insurance products. Note that goods and service tax of 4.5% is applicable on all transactions in the first year and 2.25% thereafter. Nitesh Buddhadev, a chartered accountant and founder of Nimit Consultancy, says that, in case, the policyholder stops paying the premium within two years or discontinues the policy thereafter, the deductions claimed earlier are reversed.

To be eligible for tax breaks on the maturity amount, the sum assured should be at least 10 times the annual premium paid. If in any year, the premium paid exceeds 10% of the sum assured, the maturity proceeds are liable to be taxed.

If the insurance policy is not tax-exempt, a 5% tax is deducted at source from the difference between the premium and the maturity amount. For instance, consider that you have paid 2 lakh as premium over 10 years and received 5 lakh at maturity. In this case, a sum of 3 lakh (the maturity amount minus your contribution) is subject to a 5% TDS, or tax deducted at source, by the insurance company.

When the maturity amount reflects in the income tax statement, the policyholder may be liable to pay additional tax, depending on the income slab. The 5% TDS is largely for recording transactions. If the recipient is above 80 and the amount received is less than 3 lakh, then the individual can claim refund of tax deducted. Conversely, earning professionals or businessmen may be subjected to higher taxes.

Balwant Jain, a tax expert, said that there is no proper provision that says how the insurance maturity amount proceeds should be taxed." Whether it should be treated as income from other sources where it is taxed as per slab rate or as capital gains is a question that often arises" If the insurance proceeds are distributed in case of the policyholder’s death, there are no taxes to be paid.

Kohli of ClientAssociates said investors typically prefer to park their money for the long term of 10-15 years to get more than 6-7% returns. Equities have the potential to deliver double-digit returns (say, around 10-15%). So even if you pay a 10% tax on equities, the returns can be between 9% and 13%, an attractive proposition.

Kohli, however, has a word of caution for investors. “Taxation should be given some weightage while buying a product but it should not be the only factor. People should also look at it from an asset allocation approach," he says.

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