Direct Tax Code might discourage taking life Insurance Policies and investment in pension funds

The Direct Tax Code (DTC) is in the offing.  The bill for this new income tax statue  might be introduced in the  parliament this winter.   Once DTC is in place the income tax act and rules will no longer exist.

It is perceived that the proposed new Direct Taxes Code Bill 2010, if implemented in the proposed form, will be detrimental to the interests of individual policy-holders in insurance companies.

Under the proposed DTC Bill 2010, deduction for payment towards a typical life insurance cover is allowed if the premium paid in any of the years during the policy term does not exceed 5 per cent of the capital sum assured under the policy.

This proposed cap of 5 per cent will deny benefits to large number of policyholders. For an individual aged 30, the minimum term will be around 21- 22 years and for 40 years and above, the term will be 28 years or more.

This will lead to inequity, as for the same term and sum assured, the tax exemption would be available to, say, a 30-year-old person, but not to 40-year-ld person because of higher term insurance content.

Thus, a policyholder of higher age will be forced to pay premiums beyond his working age.

To ensure that life insurance products are long term, there is a minimum lock-in period of five years. The IRDA, in its recommendation to the CBDT, has suggested that only those policies should be allowed for deductions which have a minimum maturity period of 10 years.

Hence, it will be prudent to revise the minimum term of policies to 10 years irrespective of the frequency of premium paid during the term.

Shared allocation

In DTC Bill 2010, a separate window of a much lower amount of Rs 50,000 has been prescribed for life insurance premiums, tuition fees and health insurance premiums.

With increasing costs of education and health care services, much of this small limit would be utilised, leaving little space for life insurance premium. Thus, this shared allocation, actually tries to further undermine the importance of life insurance as an asset class and deprive the benefit of social security to the policyholders.

However, the proposed Bill provides a total exemption up to Rs 1 lakh for investments in long-term savings such as Employees’ Provident Fund (EPF), Public Provident Fund (PPF) and New Pension System (NPS) with no prescribed minimum holding period for investment in these instruments.

It will be desirable to provide a limit of Rs 1,00,000 for life insurance premiums/annuities too.

Also, there are now approximately 31 crores of in-force policies and the persons holding these policies would be substantially affected if the proposed Bill is implemented in its current form, since DTC Bill 2010 does not specify grandfathering of existing policies.

Need for parity

Under the current tax regime, Section 80CCC of the Income-Tax Act 1961 provides for deduction in respect of premiums paid under IRDA approved pension fund/annuity plan. This deduction is allowed up to the aggregate limit of Rs 100,000, considering deduction under Section 80C as well.

However, under the proposed tax regime (DTC), only that amount received under NPS, which is used to buy an annuity plan, will not be taxable in the year of such receipt.

Similar provision needs to be inserted for annuity received by the policyholder from a life insurance company so as to bring parity in long term saving products.

One does get a feeling that the thinkers in the tax planning divisions feel that long-term savings through life insurance is less important for the economy than savings through Employee Provident fund, Public Provident fund and the New Pension Scheme, with the latter being  benefited through fiscal incentives.