Guaranteed ULIPs: Analysis of SBI Life SMART ULIP

I’m writing this post in response to a comment by a reader (see 'Amazing Fact about Life Insurance') who is in doubt whether ‘SMART ULIP’ from SBI Life is really smart and unique because it is offering a guaranteed NAV at the time of maturity based on the highest NAV during last 7 years.

SBI Life-SMART ULIP: Facts
Well, first let’s state a few facts about SBI Life-Smart Ulip. As per the official illustration and brochure of the SBI Life Insurance Company following facts come out about SMART ULIP:

1. Minimum annual premium is Rs 50,000. Premium paying term is 3 and 5 years while the policy term is 10 years.

2. Sum assured of SMART ULIP is 5 times the annual premium.

3. SMART ULIP offers only one fund option called “Flexi-Protect Fund”. While minimum investment in debt and equity is ‘NIL’, the maximum can be up to 100 per cent in both equity and debt.

4. As per the SBI Life-SMART ULIP official illustration which is based on a 40 year old individual paying an annual premium of Rs 50,000 for five years, maturity value at the end of 10 years is Rs. 3,03,469 if the invested money earns a rate of return (assumed) of 6% and Rs 4,09,954 if the invested money earns a rate of return (assumed) of 10%. Further, it states that ‘reduction in yield’ is 3.49% (for 6% interest rate) and 3.61% (for 10% interest rate), respectively. Put simply, as per the illustration IRR or the ‘Effective yield’ works out to be 2.51% and 6.39% for 6% and 10% rate of interest respectively.

However, if we calculate IRR of a cash outflow of Rs 50,000 each (at the beginning of first five years) and cash inflow of Rs 3,03,469 at the end of 10th year, IRR works out to be 2.44% instead of 2.51%. Similarly, for a cash inflow of Rs 4,09,954 the correct IRR is 6.33% and not 6.39%. However, this difference is not significant from the point of view of the purpose of this discussion.

5. The guaranteed NAV of SMART ULIP on maturity will be the highest of the NAV during the first seven years. In other words, if the NAV at the time of maturity (which is ten years) is less than the guaranteed NAV ( which will be the highest of the NAV during the first seven years) then guaranteed NAV will be payable.


SBI Life-SMART ULIP : Analysis
To better comprehend this analysis of SBI Life-SMART ULIP, you should first understand a few hidden secrets about ULIPs (Unit linked insurance plans). Now let’s analyse the features of SMART ULIP :

1. Low Risk Coverage: The risk coverage of SMART ULIP at just 5 times the annual premium is too low.

2. High Cost: SMART ULIP is a type I Ulip with an expense ratio of 3.61% (based on company illustration for a 40 year old individual) is too high as compared to expense ratio of best ULIPs based on IRR. In other word, IRR or ‘Net Yield’ of SMART ULIP is one of the lowest among all the ULIPs.

3. Lack of transparency: One of the advantage ULIPs have over traditional insurance plans is transparency. But, on this account also SMART ULIP is lacking. How? As per the brochure, while the minimum investment in equity and debt is specified as ‘NIL’, the maximum can be up to 100 per cent. Put another way, the company can invest in the debt and equity in any ratio as it deems fit since the fund investment is at the total discretion of the company. It is quite possible that the company may keep the majority or the entire investible surplus / funds parked in bank FDs and debt funds.

4. Lack of Flexibility: As there is only one fund option called “Flexi-Protect Fund’, the fund-switching facility in not available in SMART ULIP .

5. The Guarantee is meaningless: As regards the NAV guarantee in SMART ULIP, it is just another cheap marketing trick to garner more funds from unsuspecting investors. In fact, it is very unlikely that at the time of maturity NAV will be less than guaranteed NAV. It is highly improbable, if not impossible. Why?

First, please note that guaranteed NAV in SBI Life-SMART ULIP is the highest of the NAV during first seven years and not ten years (the duration of the Ulip plan). Second, the majority of the investment is probably going to be in debt. Now, tell me, what are the chances that the NAV at the end of 10thyear is going to be less than the NAV at the end of 7th year? Just go and ask any analyst or a portfolio manager and you’ll know.

The guarantee can make sense if the ULIP plan offers that the minimum investment in equity will be 50 per cent and the guaranteed NAV will be the highest of NAV during the entire term of the plan (and not just first seven years).

Finally, tell me do you pay any extra charges for getting assured returns from a PPF or a bank FD?

So, in summary, this Type-I ULIP product is low on insurance coverage with high expense ratio, lack of transparency & flexibility and no option for fund switching. These all demerits are on account of guaranteed NAV which is unlikely to materialize because anyway the maturity NAV will be higher than the guaranteed NAV.

This is my opinion. If you don’t agree or have a different point of view about the SBI Life-SMART ULIP , you can write in the Comment Box below.

Also see:

1. Is it Complexity or Confusopoly?

2. ULIPs - 5 Secrets

3. Capping of ULIP Charges by IRDA - A Review

4. Life Insurance - Most Amazing Thing

5. 5 Common Myths about Life Insurance

6. 10 FAQs about ULIPs

How to Calculate Your Income Tax Liability

In my previous post, a brief process for calculating your taxable income or Net Income was mentioned. Continuing with the same, in this post the process to calculate your tax liability is described in detail.

How to Calculate Your Income Tax Liability
Your income tax liability depends upon your taxable income and the applicable tax slabs / tax rates.

Under Indian income tax, there are three categories of individual tax payers (Assessees) for rate purposes: Resident women, Resident senior citizen and Other individuals. For the fiscal year / financial year / previous year 2008-09 (AY 2009-10), the basic exemption limit for resident women (not being a senior citizen) is Rs. 180,000; for resident senior citizens it is Rs. 2,25,000; and for any other individuals it is Rs 1,50,000.

The income tax slab rates for the financial year 2008-09 (Assessment year 2009-10) are:

basic exemption up to Rs 3 lakh -------– 10%,

3 lakh to 5 lakh –-------------------------- 20%

5 lakh onwards --------------------------- 30%

However, certain incomes are taxable at special rates given under the Income Tax Act, 1961. In case of resident individuals following income is subject to special rates of tax:

1. Short term Capital gains (STCG) on equity shares or equity oriented mutual funds on which securities transaction tax has been paid .is taxed at the flat rate of 15 per cent under section 111A.

2. Long term capital gains(LTCG) on listed securities (shares, bonds, debentures, government securities), mutual fund units and zero coupon bonds are taxable @ 10% without indexation or 20% with indexation at your option.(Section 112).

3. All other LTCG are taxed @ 20% u/s 112.

4. Winnings from lotteries, game shows, races, card games, gambling or betting etc is taxed @ 30% u/s 115BB.

Furthermore, a surcharge of 10% is imposed if the ‘Net Income’ exceeds Rs 10 lakh. Marginal relief is provided to ensure that additional amount payable due to imposition of surcharge does not exceed the amount by which your income is more than Rs 10 lakh.

For example, in case of ‘other individuals’ the tax on Rs 10 lakh of income is Rs 2,05,000. Now if we increase the income by Rs 10,000, the basic tax becomes Rs 2,08,000 and surcharge becomes Rs 20,800 and total tax liability works out to be Rs 2,28,800. Now, due to increase of income by just Rs 10,000 tax liability increases by Rs 23,800 (i.e. Rs 2,28,800 – Rs 2,05,000). Thus, the marginal relief of Rs 13,800 (i.e., Rs 23,800 – Rs 10,000) is provided from the surcharge so that amount of surcharge gets restricted to Rs 7000 (Rs 20,800 – Rs 13,800) and final tax liability becomes Rs 2,15,000 thereby ensuring that additional tax liability doesn’t exceed additional income.

Finally, Education Cess @ 3% is levied on the amount of tax computed inclusive of surcharge (i.e., basic tax plus surcharge) and you arrive at your tax liability.

In exceptional cases, there is tax relief u/s 89 to 91 and / or interest payable u/s 234 which needs to be added / subtracted to arrive at the final tax liability.

Example:
Let’s consider an example to calculate your income tax liability. Suppose that you’re a 30 year old male resident in India and your gross total income (GTI) is, SAY, Rs 6,50,516 (inclusive of Rs 40,000 of short term capital gains from sale of shares on which STT is paid) for the financial year 2008-09 i.e., from 1st April 2008 to 31st March 2009. Further, let’s assume that you’re entitled to a deduction of Rs 80,000 under section 80C, Rs 16,000 under 80D and Rs 12,000 under 80E. So, your ‘Net Income’ or ‘Taxable Income’ becomes Rs 5,42,520 (after rounding off). Out of this Rs 40,000 will be taxed at the flat rate of 15 per cent and balance income of Rs 5,02,520 will be taxed at the normal slab rates. So your gross tax liability works out to be Rs 63,609. Further assuming tax of Rs 35,000 was deducted at source, your final tax payable is Rs 28,610.

Let’s consider another example to properly understand the process to calculate your tax liability: Supposing you’re a male individual (less than 65 years old) where your GTI is Rs 2,20,000 which includes Rs 1,70,000 of LTCG taxable @ 20%. Further, you’re entitled for a deduction of Rs 80,000 u/s 80. So, here your taxable income should be Rs 1,40,000 (Rs 2,20,000 – Rs 80,000) which is below the basic exemption limit, but actually the taxable income comes out to be Rs 20,000. Why? Because your section 80 deduction gets restricted to Rs 50,000, which is equal to your ordinary income (i.e., GTI minus income taxable at special rates). It is due to tax provisions which bar section 80 deduction from income which are taxable at concessional tax rates under the IT Act. So, accordingly in this particular example, your tax liability works out to be Rs 4,120.

I hope by now you’re able to understand how to calculate your tax liability without any professional help. However, if you’re still confused and can’t really understand this tax mumbo-jumbo; don’t worry, I’ll try to further simplify it and make it easier for you to calculate your tax liability without any outside help. Right now, I’m in the process of devising a tax calculator which will take care of all the finer points of calculating your tax liability provided you know your taxable income.

UPDATE: This post was written based on income tax rates of FY 2008-09. For the tax rates applicable during FY 2009-10 click here and for other tax changes see: Impact of Budget 2009 on Individuals.

Also see:

1. How to Calculate Your Taxable Income

2. Income Tax Calculator: FY 2008-09

3. Income Tax Calculator: FY 2009-10

How to Calculate Your Taxable Income

The income tax you’ve to pay depends on your ‘Net Income’ or ‘Taxable Income’ which is arrived at after subtracting various deductions provided under Chapter VIA (i.e., Section 80) of the Income Tax Act from the ‘Gross Total Income’ (GTI). Therefore, the first step in calculating your income tax liability is to know your Gross Total Income.

How to Calculate Your Gross Total Income (GTI)
I’ll describe in brief the various steps to calculate your Gross Total Income under IT Act:

STEP-I: First, find out the taxable income under different heads of income. There are five separate heads of income under which your total taxable income is calculated. These ‘heads of Income’ are:

1. Income from Salary
2. Income from house property
3. Income from business / Profession
4. Income from Capital Gains
5. Income from Other sources

So, you need to first compute your taxable income under each head of income separately.

STEP-2: Give effect to Set-off and carry forward of losses of current year and earlier assessment year (if any) as provided under section 70 to 74 of the Income Tax Act, 1961.

STEP-3: Total the head-wise end-results and you’ll arrive at GTI (Gross Total Income).


How to Calculate Net Income / Taxable Income
Once you know your Gross Total Income (GTI), you’ve to calculate Net Income (NI) which is also called Taxable Income. The further steps to calculate Taxable Income are:

STEP-4: Deduct various tax deductions / concessions available to you under section 80 including 80C, 80CCC, 80D, 80E, 80DD, 80E, 80G, 80GG and 80U. Check out the details at Section 80C tax-saving options and Deductions available u/s 80 other than section 80C. The resultant figure is your Taxable Income.

STEP-5: Finally, this net taxable income has to be rounded off to the nearest Rs 10 as per section 288A. Based on this ‘Taxable Income’ you can calculate your tax liability as per the rates given in relevant Finance Act.

Example:
Let’s consider an example. Suppose that during the financial year (2008-09) your total income from salary was Rs 6,30,236 (after excluding the exempted components such as medical reimbursement up to Rs 15,000, transport allowance up to Rs 800 p.m. and exempt portion of HRA) and interest income was Rs 15,000. Further let’s say you’re having a self-occupied house property and during the year you repaid a home loan installment totaling Rs 2,05,000 consisting of interest of Rs 1,40,000 and principal repayment of Rs 65,000. Your other tax savings amounted to Rs 25,500 under section 80C. Now, let’s calculate your taxable income:

Income from Salary.................................Rs 6,30,236

Income (Loss) from House Property......Rs (1,40,000)

Income from Other Sources....................Rs 15,000

Gross Total Income.................................Rs 5,05,236

Less: Deduction u/s 8OC .......................Rs 90,500

Net Income / Taxable Income.................Rs 4,14,736

Taxable Income (Rounded off)................Rs 4,14,740

Let’s consider another example to clarify the concept of set off and carry forward of losses. Suppose that in addition to the above income you’ve short term capital loss of Rs 32,000 and long term capital gains amounting to Rs 20,000. Therefore, your net loss under ‘Capital Gains’ is Rs 12,000. Now, as per section 71, losses under the head ‘Capital Gains’ can not be set off against income under any other head; however, allowed to be carried forward to the next assessment year. Therefore, your taxable income for the assessment year 2009-10 remains the same.

Now, consider another scenario (exactly reverse of the above) where you’ve STCG of Rs 20,000 and negative LTCG (i.e., loss) of Rs 32,000. Now, your income under the head Capital Gains would be Rs 20,000 and accordingly Gross Total Income and Taxable Income also increases by the same amount. Why? Because while short term capital losses can be set off against long term capital gains, reverse is not true. Put simply, long term capital losses are not allowed to be set off against short term capital gains by virtue of section 70 of the IT Act. Therefore, you’ll have to pay tax on your short term capital gains of Rs 20,000, while your long term capital loss will be carried forward to the next assessment year.

In next post I’ll describe how to calculate your tax liability.


Also see:

1. Income Tax Calculator: FY 2008-09
2. Income Tax Calculator: FY 2009-10
3. HRA Tax Calculator
4. How to Calculate Taxable HRA

Home Loan Tax Benefits - Section 80c vs. 24(b)

Investing in a house is considered as one of the best tax-planning tools due to various tax-benefits and concessions provided under the Income Tax Act, 1961. Interest paid gets partially offset by IT benefits which results in reducing the net cost of borrowing.

The tax benefits on home loans availed for the purpose of purchase or construction of a house property are provided under two separate provisions of the IT Act.

When we borrow a housing loan, we are required to repay the loan in monthly installments spread over the tenure of the loan. The monthly loan installments are called EMIs (Equated Monthly Installments) because each installment is of the same amount. EMI consists of two parts – Principal and Interest. While Section 80C provides tax deduction for the repayment of the principal sum, section 24(b) provides tax benefit on the interest portion of the loan.

However, tax benefits under section 80c and section 24(b) of the IT Act differ in many respects. This post makes a comparison of tax implications of home loans u/s 80c with section 24(b):


Home Loans: Principal deduction u/s 80C vs. Interest deduction u/s 24(b)

1. Maximum ceiling on tax benefit
Maximum tax deduction for repayment principal component of home loan can’t exceed Rs one lakh under section 80c.

Housing loan interest deduction, on the other hand, is allowed up to a maximum amount of Rs 1.5 lakh under section 24(b). However, the acquisition or construction of the house property should be completed within 3 years from the end of financial year in which home loan was taken; otherwise, the amount of interest benefit allowed is only up to Rs 30,000.

Furthermore, the above tax deduction limit u/s 24(b) is applicable only for self-occupied house property. In case of let-out or deemed to be let out house property, interest is deductible fully without any limit.


2. Starting date for claiming tax benefit
Contrary to popular perception, deduction on principal component of home loan under section 80c is allowed as soon as you start repaying the home loan. For a second opinion or further details, please read, “Is Completion Necessary for Claiming Tax Benefit under Section 80c”.

Interest deduction on housing loans under section 24(b), on the other hand, is allowed only on acquisition or completion of the house property.

However, interest deduction for pre-acquisition or pre-construction period is also allowed but only after acquisition or construction is complete. It is allowed in 5 equal annual installments. But even after including the above, the total deduction should not exceed Rs. 1.5 lakh per annum. For further details, please read, “8 Tax Considerations to Know before Buying a House”.


3. Source of home loan
Unlike section 24(b), Section 80C doesn’t allow any tax deduction for home loans taken from friends and relatives. For claiming tax benefit on principal component of the home loan under section 80C, you’re required to borrow only from the lenders specified in that section.

There is no such restriction under section 24(b) of the IT Act for claiming tax benefit on interest component of the housing loan.


4. Purpose of housing loan - Home purchase / construction vs. Home improvement
Deduction under section 80C for principal portion of the housing loan EMI is not allowed if the home loan borrowing is for the purpose of reconstruction, renewal or repair of house property. Put simply, tax benefit under section 80C is only allowed for buying or constructing a new home and not for improvement, extension, renovation or alteration of an existing house.

In contrast, deduction for Interest is allowed under section 24(b) even for the loan taken for the purpose of repair, renewal or reconstruction of existing house property but subject to the limit of Rs 30,000 in case of self-occupied house property. In case of let out house property, actual interest is allowed without any ceiling.


5. Purpose of House Property - Self occupied vs. Let out
As already stated, section 24(b) makes a distinction between self occupied and let out (or deemed to be let-out) house property for determining the maximum amount of interest eligible for tax benefit.

In contrast, the tax benefit under section 80c remains same irrespective of whether the house property is self-occupied or let out. The only condition is that principal repayment is for home loan taken for a residential house property (i.e., commercial property is not eligible for the tax deduction u/s 80C).


6. Payment basis - Due vs. Cash basis
Tax benefit u/s 80C can be claimed only when the actual payment is made. Interest deduction u/s 24(b), on the other hand, is allowed on accrual or due basis. Put simply, unlike principal portion, interest deduction can be claimed even if not paid.


7. Restriction on sale of house property
The tax benefit under section 80c is allowed subject to the condition that house property should not be sold before a period of 5 years. If you sell the house before the expiry of five years from the end of the financial year in which you obtained the possession, the deduction will be discontinued and the entire tax deduction claimed in earlier years under section 80c – for repayment of principal component of the home loan – will be deemed to be your income (in addition to capital gains) in the year in which you sell the property.

However, the housing loan interest deduction claimed under section 24(b) won’t be reversed.

8. Home loan pre-payment: Original loan vs. Subsequent loan
Tax benefits on interest component of the home loans u/s 24(b) is allowed not only for original home loan but also for second /subsequent / new home loan taken to refinance the first loan. In other words, if the new housing loan is taken to pay off an existing housing loan, tax benefit under section 24(b) is allowed.

However, unlike section 24(b), there is no specific mention under section 80c for prepayment of existing home loan by taking a fresh home loan.

So what it means is that when you repay the balance outstanding principal component of your first / original / existing home loan by taking a second home loan, you’ll be entitled for tax deduction under section 80c but within the overall limit of Rs one lakh. Further, when you subsequently start repaying your second housing loan, you’ll be entitled for tax benefit only on the interest portion u/s 24(b) and not on the repayment of principal component u/s 80C. This is quite obvious because otherwise it will amount to double tax deduction on the principal component of the home loan.


Also see:

1. Section 80c – Conditions & Restrictions
2. 4 Ways to Claim HRA with House Loans Tax Benefits
3. Claiming HRA Tax Exemption - Tips & FAQs
4. Buying a House: 8 Tax Considerations to Know
5. Taxation of Notional Rental Income
6. Home Loan Interest Rates: Fixed vs Floating
7. HRA Tax Calculator
8. Income Tax Calculator