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Service tax hike makes life insurance plans costlier
June, 16th 2015

Service tax on life insurance plans has gone up with effect from June 1. The new service tax rate is 14 per cent (old rate 12.36 per cent) for term insurance and 3.50 per cent (old rate 3 per cent) for traditional plans in the first year and 1.75 per cent (old rate 1.50 per cent) in subsequent years.

The increase in service tax has raised the premium and will reduce the overall return on traditional plans. Traditional plans are a combination of insurance cover with a savings element coupled with tax benefit.

The entire debate after the Modi government completed one year was around growth and development, but nobody noticed that this minor change in tax rate could affect crores of insurance policyholders.

The service tax hike is a major blow to the common man, as it has not only increased insurance premiums but also raised mobile bills and cost of other services.

Until recently, the Indian insurance market was largely about traditional insurance plans. Previously only LIC was pushing these products, but private insurance firms have also been aggressively pushing these plans over the last few years.

Traditional plans are easy to sell, as they are not complex compared with unit-linked plans. Traditional insurance plans are not insurance plans in proper sense of the term, as they offer very limited sum assured against the premium paid. Nor are they investment products, as they are unlikely to beat inflation in terms of return. We need to agree that insurance distribution is agent-driven. Agents sell only those products where they earn more commission. Agents are promoting traditional plans heavily because they pay around 35 per cent commission in the first year and 5 per cent renewal commission thereafter as long as the premiums are paid. Irdai is silent and not taking any step to reduce the charges on traditional plans. These charges and the rising service tax will now make traditional life insurance plans investor-unfriendly.

The service tax journey started from 1 per cent and has now increased to 3.50 per cent in just four years. June onwards, one will have to pay more premiums because of the service tax hike. I strongly feel annual returns on traditional plans will come down to below 6 per cent per annum.

Now, it would be better to take a term plan and invest the balance in PPF, as this product also offers tax benefits and the maturity amount is tax-free. This combination of term plan and PPF can give at least 2 per cent more return compared with traditional plans.

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