Insurance—Tax benefit at risk

Budget 2012-2013 will in all likelihood change the way you look at life insurance, particularly ULIP and other traditional plans.

It has been proposed in the Budget 2012-2013, that annual premium for life insurance policy paid/payable during any years of the term of the policy will only be allowed as a deduction if it does not exceed 10% of the capital sum assured.

Section 10(10D) of Income Tax Act states that any sum received under a life insurance policy, including sum allocated by way of bonus on such policy issued after 1.4.2003, in respect of which premiums payable during any of the years during the term of the policy exceeds 20% actual capital sum assured, would be exempt from income tax.

The proposed amendment will adversely affect ULIPs in particular.

ULIPs (Unit Linked Insurance Plan) gives the option--to the proposed life assured—to choose the sum assured as a multiple of the premium payable. Sum Assured usually ranges from 5x to 20x the premium. More often than the insurance agents advise a low multiple in order to keep a larger share of the premium to be invested in the market.

ULIPs are opposite to tradition plans since the starting point is the premium one wishes to pay and calculating the sum assured thereafter. Increasing number of investors started to opt only for ULIPS with a low sum assured. Even insurance companies designed products that carried a very low/negligible life insurance cover. The products were basically mutual funds in the garb of insurance.

All this is set to change once the budget proposals are passed in Parliament.

Insurance policies can only be bought if the premium payable during any of the years during the term of the policy does not exceed10% of the capital sum assured.

Life insurance has been invented by the society as a financial tool for creating a corpus to be utilized when financial support or protection is needed by a person. It is not a savings or investment product.  With the very first installment of premium paid to an insurance company, he policy holder ensures an umbrella of financial security which is guaranteed to the family in the event of unfortunate demise of the policy holder.

Life insurance is for ensuring peace of mind and not for pieces of dividends and interests.

RAJIV GANDHI EQUITY SCHEME---DISASTER IN THE MAKING

Finance Minister Pranab Mukherjee unveiled “Rajiv Gandhi Equity Scheme” (RGES) in his Budget 2012-2013 for first time retail investors. The idea of the scheme was to reduce volatility seen in the recent times and also to broad base the equity markets. The features of the scheme are as under:-

• Only 1^st. time investor entitled to invest
• First time investors will be those who do not have a demat account and having total     income of not more than Rs. 10 lacs.
• Maximum permissible investment—Rs. 50,000/-.
• Deduction allowed @ 50% of investment from Gross total income.
• Investments will be subject to a lock in of 3 years.

 Here’s why we at AIMS believe that the scheme is a disaster in the making?

Firstly, the unveiling of a scheme like this is a pointer to the realization within the government that something is drastically wrong with equity markets and investors. With mutual fund industry shrinking in size (close to 11 lacs folios have been closed in the last financial year while increasing number of AMCs are quitting business etc.) the retail investor has for all purposes left the market—for good. The scheme is expected to bring them back into the equity market. A study done by D Swarup Committee has indicated that India’s investor population has declined from close to 20 million in 1990s to roughly about 8 million in 2009—may also be weighing heavily on FM while announcing a scheme like this.

Wrong logic

Why would an equity investor invest in equity for 3 years for only 50% tax breaks when 100% LTCG are exempt after only 1 year of holding? The better way to promote RGES was through ELSS. Though now there are feelers from the government that the lock in may be reduced to 1 year.

Wrong target audience

RGES benefit will be available only for first time investors. A first time investor is one who does not have a demat account in his name. Rather than let the first time investor access capital market through MFs and or index funds, FM exhorts them to invest directly in equities—is a perfect recipe to further lower the investor count in the country. Surely this is not the way to spread equity culture in the country.

Rather than come up with half-baked initiatives to promote equity cult in the country, government should try to focus on giving investors a taste of equity returns through mutual funds or ETFs. Though the investment is supposed to be made in top 100 companies, there are plenty of ways of having a bad investing experience in Top 100 as well. 

Inflation & Financial Plans

Today there are many factors that may have an impact on your investment decision. Factors like government regulations, interest rates, volatile stock market, an event in overseas market, inflation etc . today impacts your financial planning activity like none. They have become too important to be ignored in your financial planning exercise—especially inflation. 

If ignored, inflation can hurt your standard of living. If your income increases at a rate less than inflation, your standard of living declines even if you are making more money. Simply put, inflation means paying more for same set of services.

While evaluating a financial product, we should evaluate the expected real rate of return. For example if a financial product offers 10% pre-tax return in a year, and if inflation is 5%, then real pre-tax return is 5%.

More often than not, inflation is rarely factored in by investors while investing.  Coupon rate is more often than not the sole guiding factor. This is true even for urban investor. There is low level of financial literacy among urban consumers. Investors usually do not consider external factors impacting their financial decisions (inflation being one of them) and the options as regards choice of products to mitigate the risks inherent in the financial product. A classic case in the point is less appreciation for term plans offered by insurance companies. Though it is the best form of pure insurance, people still look for endowment plans and ULIPS forgetting the fact that insurance is not meant to generate return, but manage risks. Though there is a better awareness about different financial products available amongst urban investors, it’s suitability to one’s financial needs is lacking. They fare poorly when it comes to deciding where, when and how they need to allocate their savings. This brings us to the most important factors of a financial plan:-

Identify your goals and quantify them

Rather than saying that you need X amount of money after n number of years, it is better to say that “I need Rs. 20 lacs for my daughter’s education 20 years hence. It’s like boarding a train before ascertaining your destination (goals). Clarification about the target corpus after a definite time frame will make your asset allocation more aligned to your goals. Even this 20 lacs figure has to be arrived at taking into account the inflation. Rs. 20 lacs in today’s term or after 20 years.  Let’s take an example. Say your current age is 27 years and you plan to retire at 65. Your current annual expenses are Rs. 300,000. This means that you need to accumulate a corpus of about Rs. 1.90 crores just to maintain your present lifestyle. (Assuming you live till the age of 85 years and the inflation rate is 4%). In order to accumulate this corpus, you need to invest Rs. 6450 per month religiously for next 38 years in a retirement plan that offers 8% pa.

  

Now earning is just one side of the coin. Your earnings need to be secured also, so that in case of a misfortune, your family’s needs can be taken care of. Let’s consider the case of a healthy 25 year old person with an annual income of Rs. 100000/- pa. Let’s also assume that while his income increases at the rate of 10% annually, inflation is at 4%. At 50 years of age his real income will be Rs. 10 lacs pa... However, in case of his unfortunate death at say 42 years of age, the loss of income to his family would be nearly Rs. 500000 per annum. Hence, if he is buying a protection plan—which he should be anyway—he must aim for a cover of Rs.10 lacs.

Revisit your goals and plans regularly

Once you have zeroed in on a financial plan, it is necessary that you re-visit it, evaluate and realign it periodically. If you have invested in an equity product, then you should switch out to a debt fund as your retirement approaches near. This will not only ensure safety of your corpus, but also ensure regular cash flows.

Financial plans must be revisited and re-evaluated in line with the macro situation and life stage.

A visit to a certified financial planner can prove to be useful, after all managing money requires more skill than making it. A certified financial planner can offer proper unbiased guidance in these situations.