Monday, February 16, 2009

INVESTMENT MYTH - SINGLE PREMIUM ULIPS HELP SAVE INCOME TAX


Today in this space I would like to deal with one of the most commonly held myths about investing. Even though the savings rate in our country is among the highest in the world (@30%) In India , quite a substantial portion from the overall investment bucket of the retail customer finds itself invested with the aim of saving income tax. This in itself is not bad at all , infact that’s the reason why such tax breaks are offered. But what is worrying is that most of the people don’t have clarity on rules regulations governing such tax breaks.

As per the current income tax guidelines, one can avail tax exemptions under section 80C of the IT ACT on the money invested upto Rs 1 lakhs in a financial year. Also the maturity benefits are exempted under Sec 10 10 D of the same Act. The various investment instruments/tools which will help you save tax under these guidelines are as under:-
PPF
Insurance
ELSS
ULIPS
Housing Loan (principal component repaid).
FDs with maturity in excess of 5 years.
NABARD Bonds.
NSC
PF
School and college fees paid for your children
Now coming to the topic of our discussion, that most people think that all ULIPS (single and regular premium paying) offer same tax breaks under IT ACT. This is NOT true for single premium paying ULIPS. Let’s first examine the premise on which the single premium ULIPs are bought or sold. The salesman generally pitches the single premium ULIPs as a product where you can make one time investment without the hassles of paying at regular intervals while reaping the same tax and investment benefits. This is not true with respect to the tax breaks because in single premium ULIPS one can have minimum SA or life cover upto 1.1 times the premium paid. For example if you invested Rs 1 lakh in Single premium ULIP you need to have atleast 1.10 lakh ‘s life cover or SA on this. Since mostly people buy ULIPS for investment purpose and not for high cover they do go for such SA. Now what most people don’t realize is that under the IT ACT, tax exemption is given only to such policies where the premium paid is less than or equal
to 20% of the SA only. Here in the above example on a SA of Rs 1.10 lk, the exempted premium would be only 20% of Rs 1.10 lakhs i.e 22000 only and not the total Rs 100000 that you invested. Not only this , on maturity the proceeds too would be taxed. So overall you don’t save much tax under this instrument.

Also, understand that you could have invested the same amount under ULIPS offering regular premium payment option to save tax on the overall amount. So what are the takeaways from this. They are:
Invest in regular premium paying ULIPs for saving tax if you must..
Better still to invest in ELSS and term plan to get the same benefit with superior results.(explained in my earlier posts on this blog only).



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