ULIP insurance plans are considered suitable by many investors with regard to saving and growing their wealth for the future. This is because, depending on ULIP performance, you can get considerable returns on your investments while enjoying seamless life coverage throughout the policy tenure.
Furthermore, ULIPs also come with tax deductions under various sections of the Income Tax Act of 1961. But what are the exact regulations on the taxation of these products? Here’s taking a closer look at the same.
A basic guide to a ULIP
A unit-linked insurance plan (shortened as ULIP) is a combination of insurance and investment. The purpose of a ULIP is to ensure long-term wealth creation while providing the policyholder with life insurance. The insurance company will invest your money (premiums) in equity, debt, liquid, or hybrid funds of your choice. The choice can be made based on your risk tolerance (as all these funds come with varying degrees of risk and returns) and the goals for which you are accumulating funds. These may include the higher education of your children, buying a house, retirement planning, and so on.
You can switch between these funds periodically to either maximize your returns or protect them from value erosion due to market fluctuations. The life coverage you get functions like a standard life insurance policy. In case of your unfortunate demise within the policy tenure, the insurance company accordingly pays out the sum assured to your nominees.
Key taxation rules on ULIPs
In the case of ULIPs, you need to be aware of the latest changes in the tax regime to understand whether your policy will be liable to taxation or not.
On January 19, 2022, the Central Board of Direct Taxes(CBDT) issued a notification outlining the procedure for determining whether ULIPs are tax-exempt. The tax-exempt status of ULIP earnings will be removed under Budget 2021 if the annual premium amount exceeds Rs 2.5 lakh. Here’s a look at the tax benefits of ULIPs purchased before or after February 21, 2021.
ULIPs purchased before February 1, 2021
As ULIPs are a sub-type of Life insurance policy, the returns on the maturity of ULIPs are tax-free u/s 10(10D) of the Income Tax Act. However, for plans purchased after April 1, 2012, this is only applicable if the annual premium amount is less than 10% of the capital sum assured (for plans purchased prior to the said date, it is 20%).
As a result, ULIPs issued prior to February 1, 2021, qualify as EEE (Exempt-Exemt-Exempt) tax-saving instruments as long as the premium is within the stipulated limits. The first exemption is on the investment made in the ULIP, the second one is for the interest you earn from this investment, and the third one is on the income or maturity amount of your investment upon withdrawal. ULIPs get deductions up to Rs. 1.5 lakh on the investment amount annually as per Section 80C. The same rule applies in this regard – your premium should be less than 10% of the sum assured if you have bought your ULIP post April 1, 2012.
ULIPs issued as of February 1, 2021, or later
The budget for FY 2021–22 stated that for ULIP insurance issued on or after February 1, 2021, the proceeds from the plan will now be taxed as capital gains at the time of policy payout if the aggregate premium exceeds Rs. 2.5 lakhs in any financial year throughout the life of the policy. Any sum received by the nominee at the time of the policyholder’s death would be an exception to this rule because it would not be subject to taxation. It should be noted that top-up premiums will also be taken into account when calculating annual premiums. Long-term capital gains that are computed on ULIP proceeds issued on or after February 1, 2021, that exceed Rs. 1 lakh will also be subject to 10% taxation. Remember that this only applies if all ULIPs are regarded as equity-oriented funds.
You can therefore take advantage of all the tax benefits that were available before the Budget 2021 adjustments if you already have an existing ULIP. Subject to the modifications made, if you bought ULIP insurance on or after February 1, 2021, you might still apply for the ULIP tax benefits on the returns if the premium stays below the described annual limits.