Par for the course: Lock in returns for long term with non-par plans

Avoid these plans if you require liquidity in the short run

Debt mutual funds lost to the indexation benefit on long-term capital gains from the start of this financial year (2023-24). Many investors are gravitating towards non-participating (non-par) plans of insurance companies in the wake of this change in tax rules.

How do these plans work?

Traditional (non-unit linked) plans are of two types: participating (par) and non-par. Returns of par plans are not guaranteed as they depend on insurer performance.

“Non-par plans don’t participate in the insurer’s profits. Their returns are also not market-linked. Hence, they can offer guaranteed returns,” says Deepesh Raghaw, Securities and Exchange Board of India-registered investment advisor and founder, PersonalFinancePlan.

Non-par plans typically have a premium payment term of five to 10 years. After that, the investor could get a lump-sum payout (usually after a gap of one or two years). Alternatively, he/she can opt for an income stream that can last for as long as 30-40 years.

Guaranteed returns

The returns from these plans are guaranteed by the insurer. At the time of purchasing the plan, the investor gets information on the cash flows of these plans and can calculate their internal rate of return (IRR).

“After investing, the investor need not worry about interest rates. Even if they plummet, the insurer will pay the guaranteed rate of return,” says Raghaw.

Vivek Jain, head-investments, PolicyBazaar, informs that many of these plans are currently offering returns between 6 per cent and 7.5 per cent.

“If the cumulative premium paid for these plans is up to Rs 5 lakh, the payout on maturity is also tax-free. These plans are also eligible for Section 80C deduction. The regular premium plans offer 10x life cover,” says Jain.

Early exits are costly

If an investor has paid less than two premiums and doesn’t wish to pay any further, he/she will end up with zero surrender value.

“If you decide to exit the plan in the initial years, you will not get the entire premium back,” says Raghaw.

After paying two premiums, you can make the policy ‘paid-up’ but the benefits get reduced proportionately.

Says Pankaj Mathpal, managing director, Optima Money Managers: “In a non-par plan, you don’t get any bonus or dividends, as these plans don’t participate in the profits of the insurer.”

The tax benefits of these plans have been curtailed.

Says Vivek Jalan, partner, Tax Connect Advisory Services: “Effective April 1, 2023, the tax exemption has been withdrawn from high-value traditional life policies. Now, any payout, including non-death maturity benefit, surrender payout, etc of these policies with an annual aggregate premium of over Rs 5 lakh, will be taxable.”

Breaking up the investment into smaller policies will not do since the cumulative premium is considered for assessing whether the Rs 5 lakh threshold has been breached.

Run these checks

The IRR can vary from one plan to another.

“Select a plan that offers an IRR of 7 per cent or above,” says Jain.

Retail investors should seek expert help in calculating the plan’s IRR. Between lump-sum and income payout, choose the option that suits your needs. Retirees, for instance, may opt for the income option to meet their cash flow requirements.  

Who should opt for them?

People in their fifties who want to create a long-term, tax-free income stream after retirement can use these plans. The elderly who want to create a tax-free income stream for their children may also go for them.

Younger investors who have a small corpus, and may not be comfortable locking in their money for the long term, should avoid them. Such investors should stick to term plans.

Says Deepali Sen, founder and partner, Srujan Financial Advisers: “For a low premium, you can get a huge coverage in a term cover that can provide financial protection to your dependants.”

Those in the accumulation phase and having a horizon of more than seven years may opt for equity funds. 

The returns offered by non-par plans are correlated with the interest rates prevailing within the economy. Since interest rates are on the higher side, these plans offer reasonably attractive returns.

“Investors who wish to lock into these rates should act now before interest rates start moving southwards,” says Jain.

Pros and cons of non-par plans

·         Rate of return is guaranteed; investors can lock in the rate of return for the long term

·         In the current high-interest rate environment, many of these plans offer reasonably attractive returns ranging between 6% and 7.5%

·         If the premium doesn’t (cumulatively) exceed Rs 5 lakh, the maturity amount is tax-free

·         However, these plans have low liquidity and early exit from them is penalised

·         Most retail investors will also not be able to calculate the internal rate of return of these plans themselves