Unit Linked Insurance Plans (ULIP) are an investment instrument gaining incredible popularity over other available investment products as it combines the benefits of insurance and investment.
What is ULIP?
A unit-linked insurance plan or ULIP is a type of hybrid investment that offers customers the advantages of both investment and insurance. Your premium contribution goes into two different fields. You invest in wealth creation with the major half and get life cover with the other half of your premium. What’s more? When you choose to invest, you enjoy tax benefits on ULIP under Section 80C and Section 10(10D) of the Income Tax Act of 1961 on your premium payment if it is less than 10% of the sum assured for the policy issued on or after 1st April 2012.
For ULIPs issued before 1st April 2012, your premium payment should be less than 20% of the sum assured to claim the deduction.
Tax Benefits on ULIPs According to the New Taxation Rules
The Ministry of Finance made an amendment in FY 2021–22 under the union budget that the tax regime for high- and low-premium ULIPs needed to be different to level the playing field. Section 10 now has the fourth and fifth provisions as per the Finance Act of 2021.
Tax on High-premium ULIPs
There would be no tax exemption on the maturity benefit for the ULIP policies issued on or after 1st February 2021 if the premium paid exceeds INR 2.5 lakhs in any year.
The fourth provision states that if you have taken the policy after 1st February 2021 and paid INR 2.5 lakhs or more as a premium for the policy in a financial year, the amount received (including the bonus) at the time of maturity will be taxable.
This provison specifically relates to a certain policy. If your single insurance premium in any given year is up to INR 2.5 lakhs, only then will you be eligible for the tax exemption under Section 10(10D) of the Income Tax Act.
The fifth provison provides the exemption policy in the event of numerous approaches. If more than one ULIP is granted on or after 1st February 2021, the total premiums paid for all plans must be less than 2.5 lakhs to qualify for the tax exemption under Section 10(10D).
You can also decide which plans you want to receive tax exemption on if you have four or more policies but only two qualify for tax exemption. The total value assured at maturity will be added to your taxable income if the premium paid in any year of the tenor exceeds the limit of INR 2.5 lakhs.
Here is a short example for better understanding–
Mr. A purchased 3 ULIPs, say X, Y & Z, on 1st May 2021 with annual premiums of INR 1, 1.5 & 3 lakhs for a sum assured of INR 10, 15 & 30 lakhs, respectively. The maturity amounts received on 1st November 2031 are INR 12, 18 & 34 lakhs.
In this case, Mr. A is liable to pay tax as per the slab only on the proceeds of ULIP Z because the annual premium paid on this policy exceeds INR 2.5 lakhs. While policies X & Y will remain exempt from tax under clause (10D) as their individual as well as aggregate total premium amount is less than or equal to INR 2.5 lakhs.
No Adjustments to the Former ULIP Premium
Regardless of the premium amount you paid, if you have bought a ULIP before 1st February 2021, you would qualify for the tax exemption under Section 10(D). However, if one ULIP policy is bought before 1st February 2021 and another one after this date and the premium for both plans total more than INR 2.5, you won’t be eligible to benefit from the tax exemption on the new insurance policy.
ULIP is still one of the more appealing and viable investment options despite the new regulations.
Firstly, paying your insurance premiums combines excellent returns on investment with extra security by covering you and your dependents. And second, it continues to permit a tax benefit of up to INR 1.5 lakhs under Section 80C.
If the assesse has received multiple insurance policies in the names of their spouse and children
Under Section 80C, an individual, their spouse, or their children (regardless of whether they are dependent or independent) may enjoy a tax benefit on their premium payments.
Additionally, Section 10D also allows the Tax exemption on the payout received by the dependents in the unfortunate event of the policyholder’s demise. However, by taking three policies in the names of himself, his wife, and his children with annual premiums of up to INR 2.5 lakhs, a person may avoid falling under the fifth provison.
Taxation of ULIPs
ULIPs will be subject to the same long-term capital gains (LTCG) tax as all equity-oriented investments. Additionally, the tax must be paid at a 10% rate for long-term capital gains (LTCG) above INR 1 Lakh. However, no tax is applicable in the event of the policyholder’s death. In a nutshell, ULIP plans are comparable to stocks or mutual funds.
What Bought the Need for Modification?
Why did the government bring this amendment forward? Previously, the annual premium paid for any person during the policy period was not capped under the requirements of the Income Tax Act of 1961. It was discovered that several high-net-worth individuals were enjoying tax benefits under the clauses by investing in multiple ULIPs with higher premiums.
The new taxation rules on ULIP are said to be net-worth equalizers where lower-net-worth individuals will continue to receive tax benefits while high-net-worth individuals cannot take undue advantages.
Despite the new regulations, ULIPs remain among the most appealing investing choices. They cover you and your dependents with insurance, and your premiums combine excellent returns on investment with extra protection. Section 80C still permits a tax deduction of up to INR 1.5 lakhs a year.