Your Money: Avoid single premium plans for tax saving

A combination of ELSS or PPF with a term plan offers better coverage and returns

Single-premium life insurance policies have become popular since demonetisation was announced. All life insurance companies put together collected Rs 6,692 crore premium for individual single premium plans -- a growth of 507 per cent compared to the same period last year.

"In the initial days of demonetisation, life insurance companies were accepting old notes and issued policies. This was one key reason for the sudden spurt," according to Naval Goel, CEO and founder of Policyx.com.

Subhrajit Mukhopadhyay, chief actuary at Edelweiss Tokio Life, says that many insurance companies were also planning to withdraw old plans and launch new ones with lower interest rates. Individuals therefore rushed to lock-in their investments at a higher rate. "Banks were also flushed with money after demonetisation. Rather than keeping it idle in bank, investors could have used funds to purchase these plans that are best suited for one-time lump sum investment," says Mukhopadhyay.

The trend to push single premium plans would continue for another three months. Financial planners say that in recent years, life insurance companies have been pushing single premium investment plans between January and March, a period when many individuals look for investment products to save tax.

"While these plans have low tax-free returns of 4-5 per cent, insurance agents tell buyers that if they consider the tax benefit on investment and on returns the net benefit is much higher than fixed deposits," says Malhar Majumder, a Kolkata-based financial planner. But those opting for single premium plans don't realise that the returns are variable based on the age of person. Higher the age lower are the returns as insurance companies deduct the charges towards life cover from the premium paid. The life insurance for a 50-year old is much higher compared to a 30-35 year-old points Majumder.

In these plans, the insurance cover is usually 10 times the premium. Income tax rules say if the premium in any year is more than 10 per cent of the sum assured, the proceeds will be taxed on maturity. If a 45-year old non-smoker pays a premium of Rs 1 lakh, he gets an insurance cover Rs 10 lakh. Most plans give returns of around 50 per cent of the premium paid for a 10-year policy term. This comes to around 4.2 per cent annual returns. This is a post-tax return of 6 per cent not considering the tax benefits on investment.

Financial planners say in one-time premium payment plans, insurance companies charge an upfront insurance fee, which works like a pre-paid product. If the insured dies during the policy period, insurance companies have already recovered the entire premiums at one go. Then there are also deductions if the person surrenders the policy midway.

"If an individual uses combination of equity-linked savings scheme (ELSS) or public provident fund (PPF) along with a term plan, he will get higher returns as well insurance cover. For those who are nearing retirement, can look at retirement funds from mutual funds," says Majumder

While single premium products include traditional plans and annuity as well; it's the former that's more popular as only a handful companies sell annuity plans at present.