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Insurance can be a bad tax-saving bet

Admin 
on 30 March 2009

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In terms of returns, there are better options such as tax-saving FDs and MFs

Author : Vivek Kaul/DNA

The phone rang. I didn't pick up. The phone rang again. I didn't pick up. I wondered why she was calling when it was all over between us.
It was late in the night. The FM station was playing that immortal number from Umrao Jaan: "Har mulakat ka anjaam judai kyon hai? Ab to har waqt yahi baat satati hai humme." There couldn't have been a more apt expression for what I was feeling.
The phone rang again. This time I picked up.
"Tell me how I should go about my tax planning?" she asked. No 'hello'; not a word about how I'd been; straight to business —- was this the woman I was sad to have parted ways with?
"You tell me what you plan to do," I shot back, feigning annoyance.
"You know I pay around Rs 3,000 per month towards my employee's provident fund. That works out to Rs 36,000 for the year. So if I want to make use of the full exemption limit of Rs 1 lakh available under Section 80C of the Income Tax Act, I need to invest Rs 64,000 more. I was thinking of investing in this unit linked insurance plan (Ulip). I understand Ulips are insurance policies that club insurance and investment. Usually the individual taking the policy has 4-6 choices while choosing his investment fund, ranging from an option that invests 100% in equity to one that invests 100% in debt securities. The policyholder gets an insurance cover for which the insurance company charges a mortality premium every month. Also, this cool dude I know, who also happens to be an insurance advisor, says my money will double in three years if I invest in the Ulip that he sells."
"What else has he promised you?" I asked.
"I am not seeing him, if that is what you are asking," she replied.
"I wasn't suggesting that. What else has he told you about Ulips?"
"Oh. He has also promised that we can split the commission he earns. I invest Rs 64,000 in an Ulip and he gets a commission of 20% on that amount. Now that works out to Rs 12,800 (20% of Rs 64,000), which we split. Thus, I get Rs 6,400 back. In addition, I can stop investing in the scheme after three years if I want to. Just think! With Rs 6,400, I could buy myself that red designer dress I have looked up."
Now this was the first of its kind. A red dress would now say what tax-saving investment needs to be made.
"Has your friend told you about the returns the Ulip has given?"
"No, not really. Does it matter? Besides I want that red dress real bad."
"You don't need to invest Rs 64,000 to buy that dress. Giving kickbacks or if I may put it euphemistically sharing a part of the commission is an age old trick used by insurance agents. This makes sure that people don't ask the most significant question "How has the Ulip performed?" Now listen to me carefully. The expense structure of Ulips offered by different insurance companies is different. Therefore, there is no way an individual can figure out which is the best performing Ulip. And if you are investing your hard-earned money, you better get the best. Also, whether money doubles in three years or not depends on how the Ulip performs. There is no guarantee. Also, doubling money in three years would mean your Ulip must earn a return of 26% every year. Now, how can anyone guarantee that kind of return? Also, you need to realise that in the first two years, in order to pay huge commissions to insurance agents, Ulips have a very high premium allocation charge. This charge is made from the premium you pay, in order to pay the insurance agents and the remaining money is invested," I replied.
"For once, you make sense," she said.
"As far as investing for just three years is concerned, that is another point that is used to mis-sell Ulips. Most Ulips have a term of ten years or more. Ulips have a cover continuance option, which comes into picture after three years. If an individual who has opted for this option at the time of taking the policy is unable to pay premiums after the first three years, this option ensures that the policy continues. Agents have turned this into a mis-selling point. Also, individuals who stop paying premiums after three years lose out the most. Ulips have a very high expense structure in the first two to three years. So, less premium gets invested. After the third year, the expenses are low and only then more premium gets invested. Agents do this because their incentives are misaligned. They make the most of their commission in the first two years. So they sell the Ulip as a three-year policy. At the end of three years, they will be in a position to sell you a new policy and hence continue to earn higher commissions."
"I get the point. I guess you want me to look up some other investment avenue."
"That's right, but don't do so because I want you to. It doesn't matter now. Split your money equally between a tax-saving fixed deposit with a bank and a tax-saving mutual fund, wherein you can easily figure out the best scheme going. Now if you would excuse me, I've got things to do."

k_vivek@dnaindia.net

(The example is hypothetical)







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