Life insurance has always been a preferred investment option for all people due to the financial security it offers to a family after the demise of the policyholder. It also becomes ideal for people with a conservative risk profile.
In the budget 2023, it was announced that high-value insurance purchases would henceforth be taxed with effect from 1st April 2023. This newly introduced amendment states that taxes will be levied as per an individual’s marginal income tax rate on any income earned from life insurance policies. However, this new taxation policy will not be applicable to the life insurance policies that are issued on and before 31st March 2023. Moreover, the amount that is received on the death of the insured person is also exempt from this policy. Thus, the maturity amount of policies issued before 31st March 2023 and the amount received on the policyholder’s death will remain tax-free. Another exception to this new scheme is Unit Linked Insurance Plans or ULIPs, issued on or after April 1, 2023, whose annual premium amount exceeds Rs. 5 Lakhs.
The proposal related to levying tax on the amount earned on high-value life insurance policies has undoubtedly placed the majority of Indians in a dilemma about considering life insurance policies for their future investments or start looking for a different investment option.
Since the tax will be applicable on insurance maturity for an aggregate premium amount of Rs. 5 Lakhs a year, this amendment should not affect middle and upper-middle-class investors. It will majorly affect the high net-worth individuals who purchase high-value insurance policies to claim tax benefits and reduce their tax liability. While high-value life insurance policies could get omitted from the list of investment options of such investors, one possible unintended consequence could be the spillover effect on debt mutual funds. This is because due to taxes being imposed on these insurance policies, their demand may decrease. On the other hand, investment schemes like debt mutual funds will become a better alternative as they provide tax benefits. Subsequently, the demand for debt mutual funds will increase, causing investors to earn a higher return.
Debt mutual funds primarily invest in fixed-income securities like government bonds, corporate bonds, and money market instruments and generate returns through interest or coupon payments. They are considered to be a popular investment option for HNIs looking for a relatively safe and liquid option to earn stable returns.
Currently, debt mutual funds enjoy certain tax benefits, like indexation for long-term capital gains (LTCG), lower tax rates for short-term capital gains (STCG), and no tax deduction at source (TDS) for resident investors.
Under the present scenario, even equity mutual funds schemes such as ELSS fund becomes an attractive option for investors as they offer tax exemption of up to Rs. 1.5 Lakh a year, under Section 80C of the Income Tax Act. These funds have a lock-in period of three years, at the end of which, you will be charged a 10% tax on your LTCG if it is above Rs. 1 Lakh. For other equity funds, STCG (less than 1 year) are taxed at a flat rate of 15% whereas for LTCG (more than 1 year), if the amount exceeds Rs. 1 Lakh, the gains are taxed at 10% without the benefit of indexation.
As of now (before 31st March 2023), some of the listed companies such as HDFC Life saw a 27% growth rate in retail Annual Premium Equivalent (APE) while ICICI Prudential Life and Max Life saw a growth of 10% and 5% respectively. This growth rate is expected to reduce after 1st April, once these policies containing an annual premium of more than Rs. 5 Lakhs become taxable.
Experts are of the opinion that the government may consider reducing the debt funds’ Long Term Capital Gain, i.e., LTCG indexation benefit period from three years to one year, or increasing the Short Term Capital Gain, i.e., STCG tax rate from the current slab rates (up to 30% for individuals) to a flat rate of 25% to align the tax treatment of debt mutual funds with that of equity mutual funds.
However, this revision may reduce the demand for debt mutual funds and decrease the flow of funds into the debt market, where many borrowers rely on institutional investors for their credit needs.
Another factor that can possibly impact the debt mutual fund industry is the recent changes in the risk categorization of debt mutual funds by SEBI (Securities and Exchange Board of India). SEBI has introduced new categories based on the maturity and credit risk of the underlying securities and mandated that all schemes should comply with the new norms. While this move aims to enhance the transparency and comparability of debt mutual funds, it could also lead to a temporary increase in the volatility of the debt mutual fund market.
In the long run, the proposed tax on high-value insurance policies may have a spillover effect on the debt mutual fund industry, but no such effect is currently seen in the market. While the government may need to balance the tax parity between different investment instruments, it should also avoid disincentivising long-term investments in debt mutual funds. It is essential to maintain a stable and attractive investment climate to ensure the flow of funds to the debt market, which is crucial for the overall growth and development of the economy.
Disclaimer: The views expressed in the blog are purely based on our research and personal opinion. Although we do not condone misinformation, we do not intend to be regarded as a source of advice or guarantee. Kindly consult an expert before making any decision based on the insights we have provided.
