Single-premium Ulips can be taxing

Single-premium unit linked insurance plans (Ulips) are a popular mode of investment today, what with the last date for making tax-saving investments, March 31, approaching fast.

But there are a few things the tax saver should keep in mind while investing in a single premium Ulip.

As the name suggests, the individual taking the policy needs to pay just one premium. The majority of the premium after deducting for the premium allocation charge, which is used to pay the agent a commission, is invested. The portion that is invested is referred to as the investment fund. The premium allocation charge for such Ulips is typically around 2-5% of the amount invested.

The policy also provides a certain amount of life insurance cover, called the sum assured. The minimum sum assured on a single premium Ulip has to be 1.10 times the single premium.

Now, take an individual who pays a premium of Rs 50,000 and opts for the minimum sum assured of Rs 55,000 (110% of the single premium amount of Rs 50,000). If the policyholder expires, his nominee would get at least Rs 55,000 from the insurance company. But, for the family of an individual who is in a position to pay a single premium of Rs 50,000, it is doubtful Rs 55,000 would mean much. The individual would do better to analyse his insurance needs and perhaps get a term insurance policy, so that his family is better protected against the income uncertainty in his absence.

In India, insurance is typically sold on the premise that the premium paid can be claimed as tax deduction and the maturity amount would be tax free. But, there are certain complications in case of single premium policies.

Tax deduction
Sub-section 3 of Section 80 C of the Income Tax Act 1961 clearly states that a deduction is available only to so much of the premium, which is not in excess of 20% of the sum assured on the policy.

In the example taken above, the premium paid is Rs 50,000 and the individual has opted for the minimum sum assured of 110% of that, i.e. Rs 55,000 lakh. In this case, the single premium of Rs 50,000 works out to around 91% of the sum assured, whereas the allowable tax exemption is a maximum of 20% of the sum assured, which works out to Rs 11,000 (20% of Rs 55,000). Thus the individual cannot claim a deduction on Rs 39,000 (Rs 50,000 - Rs 11,000) of the single premium paid. If the individual is in the 30% tax bracket, the tax on this amount would be Rs 11,700 (30% of Rs 39,000).

The insurance company, of course, will not tell you this.

A typical line in the brochure of a single premium policy reads like this: “Contributions made towards the premiums will be eligible for tax deduction under Section 80 C of the Income Tax Act”. This is correct in letter, not in spirit. 

Individuals looking at single premium policies as a tax-saving investment should therefore opt for a sum assured at least 5 times the premium paid. The individual in our example should thus opt for a sum assured of Rs 2.5 lakh (5 times Rs 50,000) to be able to avail a deduction on the full premium amount.

Maturity amount
Those opting for the minimum sum assured of 1.1 times must note that the entire maturity amount is not tax free. This is because, as per Section 10 (10D(c)) of the Income Tax Act, the entire amount is tax free only if the premium paid is not more than 20% of the sum assured, in any year of the policy. Otherwise, the entire amount at maturity gets lumped with the income for that particular year and gets taxed
accordingly.

Even this, most insurance companies do not reveal in their sales brochures or at the time of selling the policy. In fact, it might be pertinent to ask how many insurance agents even know that such a provision exists.

Difficulty for nominee
The typical reason for buying a single premium policy is that the premium needs to be paid just once. However, if tax saving is the purpose, the individual must remember that such investments have to be made every year. Thus, someone buying a single premium policy in a certain year will have to buy another policy the following year in order to continue saving on tax. God forbid, but if something were to happen to him, his nominee would have a harrowing time claiming the sum assured on different covers, filing separate claims for each. Imagine a situation where the covers are from different companies and each insurer insists on getting the original document to clear the claim!