ULIP or unit linked insurance plans are meant to serve two financial goals i.e. insurance and wealth creation. Premium for the policy is segregated and part is invested into the fund created as a result of a pooling of funds from various investors and other is put into for the purpose of mortality charges, allocation charges and fund management charges. Now these funds are put into debt and equity funds and returns vary based on the performance of the fund.
Other features of a ULIP plan
1. Premium paid towards the ULIP plan can be claimed for deduction under Section 80C up to the limit of Rs. 1.5 lakh in a financial year.
2. Maturity proceeds are also tax free
3. Investors can choose between debt and equity funds based on their risk appetite and financial goals.
4. ULIP plans come with a lock in of 5 years. But during this time, there is a provision which allows switching between funds and on the capital gains made on them arises no tax implication. Further there are no STT or other such levies.
How ULIP taxation changes as per proposals made in Budget 2021?
ULIP proceeds were tax free until now, even the amount payable upon insured's death
Until now, proceeds from ULIP were tax free as long as the premium for any year did not exceeded 10% of the Sum assured value under the Section 10(10D). Also, any amount payable on death of the insured under the ULIP plan was also fully tax free regardless of the premium amount paid. But as in the case of mutual funds, any gains over Rs. 1 lakh attracted 10% long term capital gains implication, there was sought parity between the two products i.e. ULIPs and mutual funds that are both considered investment products.
With tax advantage on ULIPs in comparison to mutual funds, many HNIs and high income earners put their money in these products to get tax free returns.
What changes for ULIPs as per Budget 2021?
Now to bring in parity between mutual funds and ULIPs, the Budget 2021 amended the Income Tax Act, 1961 and accordingly any gains from a ULIP policy shall be treated as capital gains in case the premium paid for any year exceeds Rs 2.5 lakhs. Such policies will now be taxed at 10 per cent at maturity.
The change will be enforced for all ULIP policies issued after February 1, 2021. So, those already running their ULIP policies with a premium of over Rs. 2.5 lakh in a year shall not be affected. Meaning to say such investors continue to get tax exemption in respect of proceeds even if their premium is on a higher side.
Besides STT or securities transaction tax will also apply when redeeming the ULIP policy. Also, in case an investors holds different policies, then aggregated of the premium shall be considered for deciding the taxation aspect.
Thus, ULIPs will now be treated at par with equity oriented funds in section 112 A and provisions of sections 111A and 112A will apply on the sale/redemption of such ULIPs.
How should investors invest in ULIP plans post its treatment at par with equity funds?
Now to continue enjoying the tax exemption on ULIP proceeds (together with the dual advantage of insurance and investment), investors can stick with low value ULIPs that come with low premium i.e. up to Rs. 2.5 lakhs. Also, you need to select the insurer with good fund managers and offering a solid track record of long term returns.
But for novice investors, they shall be better off by segregating their investment and insurance plans.