A Unit Linked Insurance Plan (ULIP) is a type of life insurance with an investment component attached. Similar to any other life insurance, one is required to pay premiums. The premiums are then partially used towards providing life coverage and partially invested in funds of their choice. Based on the risk appetite and financial goals, one can choose where they want to put their money. One of the remarkable features of ULIP is that one can switch between these investments anytime they want. With a ULIP return calculator, an individual can plan their investments better. ULIP ensures the policyholder has financial safety (via life insurance) while earning returns on their investments. The unique composition of a ULIP helps the policyholder get tax benefits on multiple levels of the investments. Here is the new rule on ULIP taxation and its impact on current norms:
New regime for ULIP taxation after budget 2021
The Union Budget of 2021 has made some reforms to the Income Tax Act of 1961. The latest amendments to the budget reflect that any gains one earns from tax-saving instruments like a ULIP will be considered capital gains if the premium amount exceeds Rs 2.5 lakhs and the amount will then be taxed directly at 10% when the plan matures. Also, the latest amendment reflects that when a ULIP is redeemed, a Security Transaction Tax (STT) will also be levied. Basically, ULIP will be treated similarly to other equity investments during sales and redemption, according to Section 111A and Section 112A of the Income Tax Act. The changes apply to those ULIPs purchased after the 1st of February 2021.
ULIP taxation on current norms
After the tax updates made in the budget for 2021, here is how the ULIP taxation currently works:
- Tax exemption under 80C
Section 80C of the Income Tax Act allows the taxpayer to avail of deductions of up to Rs 1.5 lakh on the purchase of a ULIP. This means that you can claim tax exemptions on the premiums you pay for your ULIP. However, in order to get this exemption, the premium you pay should be less than 10% of your sum assured if you have bought a ULIP after 1st April 2012.
- Tax exemption under 10 (10D)
Section 10 (10D) of the Income Tax Act reflects the ULIP tax benefits you get when it matures. The maturity amount is exempt from taxes if the premiums paid are less than 10% of the sum assured. If the policy was purchased after April 2012, then the premiums paid should be less than 20% of the sum assured to claim tax exemptions.
- Maturity taxability for ULIP purchased before 1st February 2021
Section 10 (10D) of the Income Tax Act states that the maturity of ULIP is exempt from taxes if the premiums paid are less than 10% of the sum assured. If the policy was purchased before April 2012, the premium paid is required to be less than 20% of the sum assured in order to claim the ULIP tax benefits on maturity.
- Maturity taxability for ULIP purchased on or after 1st February 2021
If the premiums you pay on your ULIP exceed Rs 2.5 lakh, the returns on them are directly subjected to taxes. The gains on ULIP will be treated as capital gains if the rate of return exceeds Rs 1 lakh. Also, there is a direct 10% charge for equity investments and 20% on other forms of investments.
- Taxation based on funds
The tax deduction you can claim on the investment aspect of your ULIP depends upon the fund you have selected and its proportion. If your fund allocation is such that your investment contains over 65% of equity funds, your investment will be considered an equity fund. With an indirect equity fund like an ETF, the fund is to be taxed as an equity fund if the equity allocation is at least 90%. Any equity fund over and above Rs 1 lakh is directly subjected to taxation. Section 112A reflects that a 10% tax is directly imposed on any profits that arise from units of Equity Oriented Funds. While a 20% tax is charged for any profits that arise from units of Debt Oriented Funds.
The above tax rates and reforms are subjected to changes in time. A ULIP is an exceptional product, that, along with tax benefits, provides protection in case of emergencies, along with returns on investments. The several benefits of the plan make it a must-have to include in your portfolio. It is important to research thoroughly and use tools like the ULIP return calculator to maximize your ULIP returns.