The thought process behind this amendment is that ULIPs should not be viewed as a vehicle only for investments or tax efficiency.
Unit Linked Insurance Plans (ULIPs) are investment vehicles wrapped with insurance coverage. The attraction for ULIPs from investors’ perspective, or for comparison of product features, revolves around the investment aspects – track record of underlying fund, expenses charged, portfolio composition, etc. It is not so much about the insurance coverage provided under the policy. Tax efficiency vis-à-vis other investment vehicles – mutual funds or stocks or bonds – was another selling point of ULIPs, which has been plugged in the latest Union Budget. We will examine the taxation rules of ULIPs, so that investors can plan accordingly.
Deductions under section 80C
Tax benefits under section 80C of up to Rs 1.5 lakh per financial year continues to be available for life insurance policies. This is on life of self, spouse or children. Deduction under section 80C, for tax benefit, is restricted to 10 percent of the sum assured. If a person pays a very high amount of premium for an insurance cover, the deduction shall not be allowed for the entire premium. Deduction under section 80C is allowed only if you contribute to the ULIP for the first five years of the plan. The more important provision in the context of taxation of ULIPs is section 10(10D). This section provides that maturity proceeds, including bonus, are exempt from tax. The requirement is that the annual premium payable for the policy should not exceed 10 percent of the sum assured. If at any time, the premium for the year exceeds 10 percent of the sum assured, the proceeds become taxable. There is no change here as well in the Finance Act 2021-22.
Then what has changed? The Finance Act 2021-22 states that no exemption shall be available for ULIPs issued after February 1, 2021 (the day of the presentation of the Union Budget), if the amount of premium for any of the years during the term of the policy exceeds Rs 2,50,000. Hence, if an investor holds a ULIP policy that was bought prior to February 1, 2021, irrespective of the amount of premium paid, the maturity proceeds are tax-free. Where the investor holds multiple policies, issued after Feb 1, 2021, proceeds will be tax-free as long as each policy has premium less than Rs 2.5 lakh and the aggregate of all the policies of the investor (as per the PAN) is less than Rs 2.5 lakh. If the investor has multiple policies with some policies of less than Rs 2.5 lakh premium and some with higher premium, those policies with less than Rs 2.5 lakh premium, individually and as an aggregate, will be exempt from tax. Let us take an example. Mr A has four ULIPs, with premium amount of Rs 1,00,000, Rs 75,000, Rs 50,000 and Rs 40,000, respectively per year. The first three policies are all of less than Rs 2.5 lakh and the aggregate is Rs 2.25 lakh per year, and will be exempt from tax. The last one will not be exempt because if we add that, aggregate premium would be more than Rs 2.5 lakh. From another perspective, it is possible to leave out one of the first three and claim the last one, of Rs 40,000 premium for tax exemption. However, that would not be optimum as the aggregate amount claimed for exemption would be less than Rs 2.25 lakh for Mr A.
Then comes the question of taxation or tax rate. Policy proceeds will be taxed as capital gains. The time period, for computation of long-term or short-term nature of capital gains will be counted from the date of payment of premium (separately for each payment) till the date of receipt of maturity proceeds. The bifurcation between long and short term is a time period of one year. Long-term capital gains are taxable at 10 percent plus surcharge and cess as applicable. If the ULIP fund has more than 65 percent of the portfolio in equity, it will be classified as equity for capital gains taxation. In equity investments, long-term capital gains are tax-exempt upto Rs 1 lakh per financial year, but that is along with investments in equity stocks and equity-oriented mutual funds. Hence if the ULIP investor has investments in equity stocks and/or equity mutual funds and has booked profits in that financial year, only the balance will be available for ULIPs. If the taxation on the final proceeds is due to breach of Section 10(10D), i.e., premium exceeding 10 percent, it is taxable at your marginal slab rate, usually 30 percent plus surcharge and cess. If it is due to breach of the threshold of Rs 2.5 lakh, it is taxable as capital gains.
The thought process behind this amendment is that ULIPs should not be viewed as a vehicle only for investments or tax efficiency. If it is a vehicle for investments, taxation should be at par with other investment vehicles.
For pure insurance, there is term cover.