During this time of the year, one of the major cause of concern for most people is how to maximize their tax savings. So, even if they get a small advise from someone which can save some tax, they might want to consider it. The problem with this approach is that, even though one might get short-term benefits of lower tax, it might lead to long-term losses (or lower profits). Tax saving should always be a side effect of implementation of a long-term wealth creation and preservation program.
It can be proven by data that most people in India buy life insurance for the sole purpose of tax saving. In spite of this being financially foolish, it’s a real fact. People forget that the main purpose of life insurance is to protect the future of dependents and cover all current and future expenses, in case of death of the policyholder.
The best and cheapest option to buy an insurance cover is to purchase a term plan It’s very cheap and gives big-enough payout in case of death of the policyholder. Some people do not consider term plans as a good option, as it does not have any survival benefits. But simple maths suggests that money saved by not buying traditional insurance plans like money back, endowment, etc. and instead buying term plan, can be invested in other assets. This separate investment grows into a bigger corpus with passage of time.
Another mistake which people make is that they only consider tax benefits at the time of purchasing the policy. Most people don’t think about taxation of amounts at the end of the policy. In case of death of insured during the policy period, the amount paid to the family is 100 percent tax-free. For policies with survival benefits, the amount is also tax-free at maturity. But in case of surrender of policy before maturity, the tax liability will depend on the number of premiums paid. If five premiums or more have been paid, there won’t be any tax liability.
This is how policies are taxed in India. As you can see, it does not make sense to buy a life insurance policy only for the purpose of tax saving.