(As Published in Economic Times on June 13, 2016)
If you do a dipstick survey, nearly 100% of taxpayers would have bought life insurance. The irony is that nine out of 10 of these buyers would have bought insurance for the wrong reason: to save tax. Despite efforts by financial experts and the media to spread awareness about the importance of insurance as a protection tool, insurance continues to be seen as a tax-saving device. Indeed, the January-March quarter is the busiest for insurance distributors because 70% of their business gets transacted during that period. But this is also the period when taxpayers make the mistake of buying insurance for tax savings. In the process, they end up with high-cost policies they don’t need. Here are three reasons why insurance is a bad choice as a tax saving instrument:
Requires multi-year commitment
Tax saving investments under Section 80C are no different from regular investments so one should apply the same parameters to assess them. Insurance is a long-term contract that requires a multi-year financial commitment. An individual’s priorities change over time. Suppose a taxpayer takes a home loan to buy a house 2-3 years later. A large chunk of his Section 80C limit will be taken care of by the home loan principal repayment. But the insurance premium will force him to continue putting money in the policy even though he doesn’t need to make tax saving investments.
Higher costs, lower returns
Many other investment options under Section 80C offer better returns than insurance at a lower cost. The PPF and Sukanya Samriddhi Yojana have no costs at all, while ELSS mutual funds charge only 2-2.5% and offer far better returns than insurance policies that yield barely 5-6%. The low yield from insurance is largely due to the higher costs that go into paying commissions to brokers. More importantly, options such as ELSS, Sukanya and PPF offer flexibility of investment wherein the buyer can invest at any time of the year and any amount that suits his pocket.
Tax deduction is not core
The tax deduction offered on life insurance is not the core objective of the policy. A term plan of Rs 1 crore can help safeguard the financial future of the family if something untoward happens to the breadwinner. For a 35-year-old man, the premium for such a plan is only Rs 10,000-12,000 a year. On this the tax savings in the highest tax bracket work out to only Rs 3,000-3,600. Buyers should not even take this insignificant amount into consideration when they buy protection for themselves.