Covid, income fears see shift to single-premium plans. How good are they?

Those buying these plans should bear in mind that gains at maturity may not be tax-free

Individual single-premium life insurance policies are finding many takers today. By September 2020, these policies had garnered Rs 20,494 crore in new business premium during the current calendar year, a 16 per cent increase over the same period last year.

The pandemic has provided a fillip to the demand for these products. People facing income-related uncertainty are choosing to make a one-time payment, instead of committing themselves to large annual premiums.

Capital preservation takes priority: Risk aversion, too, has risen, spurring a shift towards non-participating traditional plans that promise a fixed rate of return upfront. "With the returns on bank fixed deposits (FDs) coming down, non-participating plans have become popular. They can guarantee a return of 5 per cent or slightly more for as long as 20 years. Many people are opting for single-premium plans of these products," says Santosh Agarwal, chief business officer-life insurance, Policybazaar.com. In addition to a rate of return that is similar to that of bank FDs, investors also get a small amount of life cover and Section 80C tax benefit in these plans, she adds.

Single-premium plans are suited for people with fluctuating incomes. "They enable people with flexible income sources – like freelancers or those who have received a bonus – to invest in a life insurance-cum-investment product that suits their risk appetite," says Bharat Kalsi, chief financial officer, Bajaj Allianz Life. People who have received a lump sum, say, because they have sold an asset like a house, also like to park their money in these plans.

Regular plans have their own benefits. "The financial burden becomes manageable as one can opt for the monthly or quarterly payment mode," says Kalsi. He adds that in unit-linked investment plans (Ulips), investors get to invest at different stages of the market cycle. This allows them to average out their cost of purchase of units.

In regular-premium plans, the premium pinches less as time goes by as the policyholder’s salary increases and inflation erodes the value of the premium. Regular premium plans also offer a benefit in case of early death. “The insured gets the full sum insured even though he does not pay premiums for the full tenure, unlike a single-premium policyholder who would have already done so,” says Arnav Pandya, certified financial planner and founder, Moneyeduschool.

Customers witness a large outgo of capital right at the start of the tenure in a single-premium plan. "If at any stage the policyholder wants to stop payments and exit the policy, he does not have that option since he has already paid the entire premium upfront,” adds Pandya.

Taxation can be different: People opting for these plans must understand that they may not enjoy the same tax benefit as regular-premium plans. "In a regular premium plan, the gain on your investments at maturity is tax-free under Section 10(10D) of the Income-Tax Act since the life cover is usually 10 times or more than the annual premium. In a single-premium plan, the insurance cover is barely 1.25 times, so these plans are not eligible for this benefit," says Agarwal.

In other words, your gains will not be tax-exempt here. Let us understand this with the help of a simple example. A person buys a single-premium insurance policy with a sum assured of Rs 1.5 lakh. He pays Rs 1 lakh as premium. The policy term is eight years. The net income on maturity is Rs 50,000. “The maturity proceed reduced by the premium paid is taxed as the policyholder’s ‘other income’. He will be taxed according to the tax slab to which he belongs in the year that the policy matures,” says Archit Gupta, founder and chief executive officer, ClearTax.

There will also be tax deduction at source (TDS) at the rate of 5 per cent on the income component. In the above example, this will amount to Rs 2,500 (5 per cent of Rs 50,000). No TDS will be deducted if the maturity amount is less than Rs 1 lakh.  

Another point that prospective buyers of single-premium plans need to know relates to Section 80C tax deduction. The maximum limit for Section 80C tax deduction, as you would be aware, is Rs 1.5 lakh per financial year. “However, any premium amount that is in excess of 10 per cent of the sum assured does not qualify for tax deduction under Section 80C,” informs Gupta. This is assuming that the premium paid in a single-premium life insurance policy exceeds 10 per cent of the sum assured. In the above example, A pays Rs 1 lakh as premium and the sum assured is Rs 1.5 lakh. He will get a tax deduction of Rs 15,000 only.

If the policyholder terminates the policy within two years or before paying premiums for two years, the deduction allowed in earlier years becomes the income of the policyholder in the year of termination.

What should you do? If you decide to buy a single-premium policy, compare the premium you will pay with what you would pay in a regular premium policy over its entire tenure. "The insurer should give you an attractive discount for paying the money upfront," says Pandya.

Single-premium plans are available for all kinds of policies—traditional plans, Ulips and annuities. Investors should weigh the pros and cons of these policies before going for them. Pandya, for instance, says that better alternatives are available than non-participating traditional plans promising a 5 per cent plus kind of return. "If you are investing for a long span, say, 20 years, and you want tax benefit, you will be better off in an equity-linked savings scheme (ELSS). You will get tax benefit, a better rate of return, and also enjoy better liquidity," he says. Pure equity funds and equity-oriented hybrid funds are also likely to give better returns over such a long period. Only very conservative investors, who want to fix their rate of return, should opt for these non-participating plans.  

Finally, if you are going for a single-premium plan, link the time when the policy matures to a financial goal.