New Life Insurance Rules: Lower sum assured in ULIPs, better returns but higher tax

IRDA, the insurance regulator, announced a few changes to product structures of life insurance plans through its latest regulations on linked and non-linked life insurance products. Unit-linked insurance plans or ULIPs are linked products while traditional insurance plans are non-linked products.

Here are some of the prominent changes.

As per IRDA Linked Insurance Product Regulations, 2019, the revised minimum Sum Assured (minimum death benefit) shall be as follows:

Earlier, the Minimum Sum Assured was linked to the entry age of the policyholder. If you were less than 45 at the time of entry, the minimum Sum Assured would be 10 times the annualized premium.  Following is an extract from IRDA Linked Insurance Products regulations, 2013.

In a way, it is a positive change. The higher the Sum Assured, the more you pay towards mortality charges. And that lowers your returns. Mortality charges are the charges that you incur to get life cover in a ULIP. Since the life cover has gone down, you will incur less of mortality charges. Now that the Minimum Sum Assured has been brought down to 7 times the annual premium, you can possibly earn slightly higher returns in your ULIPs. The impact will be higher for Type II ULIPS as compared to Type I ULIPs because the impact of mortality charges is higher with Type II ULIPs.

Do note most insurance companies may still continue to offer a minimum Sum Assured that is 10 times the annualized premium.  Or at least offer you a choice to sign for Sum Assured that is 10 times the annualized premium.

Why?

This is because the maturity proceeds from your ULIP are exempt from income tax if the Sum Assured is at least 10 times the annual premium.

Therefore, if you sign up for a ULIP where Sum Assured is 7 times annual premium, your fund corpus will certainly grow faster (as compared to Sum Assured of 10 times annual premium). However, that does not mean that you will certainly end up with higher maturity proceeds (because of taxation). That will boil down to your tax bracket at the time of policy maturity, variant of ULIP, your age and its impact of mortality charges and the returns you earn on the corpus. Moreover, you are getting a lower life cover.

By the way, for the single premium plans, the minimum Sum Assured has gone up to 1.25 times the Single Premium (for those above 45 years at the time of entry). Earlier, the Minimum Sum Assured was 1.25 times for those up to 45 years and 1.1 times for those above 45. For single premium plans, the Sum Assured has gone up from 1.1 times to 1.25 times for those above 45. Therefore, the returns for such investors will go down because of higher mortality charges. Quite the reverse.

By the way, I do not prefer investing in regular premium and single premium ULIPs.

Many of us understand that we have made a bad investment right after we pay our first premium in a traditional life insurance plan. The agony gets multiplied when you figure out that you won’t get anything back till you have paid at least 3 premiums. The unfortunate part is that most of us find it difficult to come to grips with the concept of sunk cost. So, we want something back. To get something back, we need to pay at least 3 premiums. There is limited relief on this front.

Earlier, your traditional life insurance policy acquired Surrender value after 3 years. Now, your policy will acquire surrender value after 2 years. Many wait and pay premiums for at least 3 years so that they get at least something back. The wait will now be shorter.

The Surrender value will at least 30 percent of the total premiums paid if surrender in the second policy year. 35 percent in the third year and 50 percent if surrendered between the 4^th and the 7^th year. Well, even this is quite a big hit.

At the same time, as I have mentioned many times before, the traditional life insurance plans make for poor investments and must be avoided.

Earlier, you could commute (withdraw lumpsum) 1/3^rd of the accumulated corpus in the pension plan from the insurance at the time of maturity. Now, this threshold has been increased to 60 percent of the accumulated corpus (in line with NPS). The increase in threshold is both for the unit-linked pension plans and traditional pension plans.

Remember, as per the income tax laws, only 1/3^rd of the lumpsum withdrawal is exempt from income tax. Even though IRDA has relaxed the rules, there is no leniency from the Income Tax department, at least till now. You will have to pay tax on withdrawal in excess of 1/3^rd of the accumulated corpus. In NPS, 60 percent of the lumpsum withdrawal is exempt from income tax.

If you must purchase a pension plan and the choice is between NPS and pension plans from insurance companies, go with NPS. NPS is a better product. NPS fetches you better tax benefits on investments, gets better tax treatment on maturity, is low costs and is relatively transparent and flexible with respect to investments.

When you purchase a pension plan from an insurance company, you are forced to purchase an annuity plan (at plan maturity) from the same insurance company.

Now, the insurer will have to give you an option to purchase annuity plan up to 50 percent of the proceeds net of commutation (50 percent of the amount left after lumpsum withdrawal).  Some choice to the investors.

After the 5^th year, you will have an option to reduce your premium in ULIPs. You can decrease the premium by up to 50 percent of the original premium. Your death benefit under the plan can be revised accordingly. Remember, this is a one-way street. Once you reduce the premium, you won’t be able to increase it in the future.