The introduction of taxation on debt mutual funds and high-value participatory life insurance policies may make bank fixed deposits more attractive. Earlier, interest on bank deposits was taxed at individual rates, while debt mutual funds enjoyed LTCG of 20% with indexation, and life savings products had tax-free returns.
The move to remove tax benefits from life insurance products and debt mutual funds may help in redirecting funds towards bank deposits to support credit demand in the economy. However, the overall impact of removing tax benefits from both sectors is not seen as favourable for any industry.
Prudent investors will likely reassess their asset allocation based on their risk profile and life stage. Recent developments may lead to a potential shift in allocation in favour of life insurance products, both unit-linked insurance plans (ULIPs) and traditional policies.
The removal of long-term capital gains tax (LTCG) with indexation benefits on debt mutual funds has potentially levelled the playing field for long-term debt products. However, the life insurance industry did not receive the sought-after relaxations from the finance ministry. Industry experts suggest that with this change, the insurance sector might find itself in a slightly better position. Customers seeking tax-free returns under Rs 5 lakh investment per year may opt for guaranteed products offered by life insurance companies.
The changes
The Finance Bill presented in Parliament, without amendments to the tax changes proposed in this year’s Union Budget, has significant implications. According to analysts, the alteration in taxation for debt mutual funds eliminates tax arbitrage, bringing all debt products on par with each other.
Before the Budget, life insurers enjoyed an advantageous position with no tax on debt savings. However, post-Budget, they faced a less favuorable situation with full tax on premiums exceeding Rs 5 lakh. The recent change makes them neutral as alternate debt investments are also taxed at the marginal tax rate. Analysts consider this a marginal positive for life insurers, leveling the playing field for long-term products.
The removal of indexation benefits from debt mutual funds puts insurers in a more competitive position. The competitiveness of the product will now determine the demand for various financial products, and insurers will not be at a disadvantageous position.
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