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Deferred payout from insurance plans is tax free: Should you invest in these plans?

Though deferred insurance payout plans are tax-free, investors should consider several other factors before investing in them.

, ET Bureau|
Apr 15, 2019, 06.30 AM IST
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Deferred payout plans are considered superior to annuities due to several reasons.
Deferred payout plans from insurance companies are in the news. These plans allow the maturity value to be paid out over a period of time once the policy ends. Since these products also offer monthly payout options, they compete directly with annuity plans. So should you opt for them?

The renewed interest in deferred payput plans is due the launch of Sanchay Plus by HDFC Life Insurance. Though competing products are already available in the market, Sanchay Plus got attention because the payments can be extended up to the age of 99.

“In addition to receiving regular income till the age of 99, the 6.3% annualised return being offered is the highest in the industry right now. However, other insurers may soon come up with competing products,” says Santosh Agarwal, Head of Life Insurance, Policybazaar.

Deferred payout plans are considered superior to annuities due to several reasons. First, the plans offer insurance cover, which annuity products do not. “The life cover offered during the premium paying term— usually till retirement—works in favour of the policyholder,” says Abhishek Mishra, CEO, Bonanza Insurance.

Secondly, annuity receipts are taxable, but receipts from deferred payout plans are not. This is because these plans have insurance cover and are tax free under Section 10 (10D) of the Income Tax Act. Since the rates of return offered by both are similar, the taxation differential makes deferred
payout products more attractive.

However, deferred payout plans don’t score too well when compared with some other products. Investors need to consider several factors before buying them.

How deferred payout plans stack up
Deferred payout plans are good for people who want guaranteed income over the long-term and are in the highest tax bracket even after retirement.
Deferred-insurance-plans

  • Flexibility
While lack of flexibility can be a drawback of products like annuity and deferred payout plans, it can prove to be a boon later. The accumulated corpus ensures a guaranteed income in later years even if the returns are lower than market rates. “Investors should park a portion of their retirement corpus in these. The remaining corpus can be invested in flexible products like mutual funds or Ulips,” says Agarwal. Deepak Yohannan, CEO, My Insurance Club, agrees. “Since most people need some capital after retirement, one should not lock their entire corpus in non flexible products,” he says.

  • Taxation
The Senior Citizens’ Savings Scheme, offering 8.7% interest and quarterly payouts, is the most preferred product among retirees now. However, for people in the highest tax bracket, the post-tax return is only 6.09%. Therefore, deferred payouts with 6.3% tax-free return is better for people in the 30% bracket. “Consider the difference in returns. Go for higher yielding products if post-tax returns are higher than tax-free returns,” says Ram Medury, Founder, Jama.co.in, a wealth management firm.

Using the deferred withdrawal facility for tax-free products like PPF is a good strategy. Though the PPF’s tenure is 15 years, investors can extend it by blocks of five years. Once you are done with investing, there is need to withdraw everything in one go. The maturity value can be retained without making any further deposits. The 8% interest earned on this accumulated value is better than the rates offered by bank FDs. However, as withdrawal is allowed only once a year, flexibility is an issue.

You can manage regular income and taxability issues by opting for systematic withdrawal plans from mutual funds. “Tax incidence will be low because capital gain from equity funds is tax free up to Rs 1 lakh per annum. Similarly, the LTCG tax on debt funds is also only 20% after indexation,” says Medury.

  • Interest rate
While you lock into current interest rates in deferred payout plans, the payments start only after a few years. So should you lock in now or use other instruments to accumulate money and decide later? “Deferred payout plans need you to guess now what the interest rates will be five or 10 years later. The call can turn out to be good if interest rates fall and annuity offered is low or bad if the annuity offered is high. Go ahead only if you are comfortable with the current interest rates,” says Yohannan.

Investors should note that while the current rates being offered by products like SCSS and PPF is high, they may fall in future. Returns generated by debt funds can also be lower. “The chances of interest rates going down in future is high. Hence, it makes sense to lock into current rates. Deferred payout options are useful for people who want fixed returns for the long term,” says Mishra.
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