In the modern world today, tax-saving is more simplified. You have several options, easily available comparisons, competitive rates, online buying ease, and more. Over recent years, given the significant economic changes like demonetisation, extreme market volatility, COVID-19 pandemic, etc., the returns of several previously-lucrative tax-saving investment options have been impacted. However, this has, in turn, highlighted the importance of insurance as an investment option.
That said, a major drawback of insurance is the lack of investment component, which lowers returns. But ULIPs (Unit Linked Insurance Plans) are an effective alternative overcoming the advantages of traditional insurance plans. ULIP plans help to reduce your tax liability while also enabling you to meet your short-term and long-term financial goals through attractive investment returns.
Here is everything you should know about ULIP policy and why they are an effective tax-saving instrument:
A ULIP is a multifaceted insurance plan that combines the best features of an insurance plan and a market-linked investment option. In a ULIP, a part of your premiums is directed to provide you with a secure life cover while the rest of the premiums are invested in lucrative equity and debt market instruments. ULIP investments are considered as of the best tax-saving options as they offer an ideal amalgamation of high returns, the safety of funds, insurance protection and optimum tax savings. You can calculate your absolute returns by the current and initial NAVs (Net Asset Values) of the ULIP, expressed as a percentage of the initial NAVs. This is one of the most effective ways to know the ULIP's performance, especially in a short duration.
When you choose to invest in a ULIP policy, the insurance provider invests a part of the premiums you pay in shares, bonds, or a combination of them all. The concept of ULIP is like a mutual fund that offers you attractive returns in the long-term. Further, the insurance company directs the remainder of your premiums towards providing you with an effective insurance cover. This enables you to enjoy both benefits of investment and insurance while saving significantly on taxes.
Typically, ULIPs are operated and managed by fund managers. These managers handle your investments as per your risk appetite and financial objectives, and therefore, levy ULIP fund management charges in return.
Generally, the ULIP policy comes with a lock-in period of five years to balance out the market forces and ensure higher returns for the investor. In this period, you cannot withdraw your investment funds and let the wealth accumulate over five years. [PG1] [Bh2] Typically, whole life ULIP plans have a lock-in period of five years. However, you can alter your portfolio or investment allocation over the ULIP plan term.
Apart from providing a life cover and attractive investment returns, ULIPs also offer multiple tax-saving benefits.
1. No tax on premiums
Section 80(C) of the Income Tax Act, 1961 allows tax deductions on specific investments and payments made. Life insurance policies and term plans for self, spouse or children are also exempt from taxes up to ₹1.5 lakhs annually. This provision is available for all Indian resident individuals and Hindu Undivided Families (HUF).
For taxation purpose, ULIPs are also considered a part of the insurance policies, and therefore, ULIPs also enjoy the same tax exemptions. All premiums paid (up to ₹1.5 lakhs) for a ULIP are free from tax under Section 80(C). However, the total premium amount should not be more than 10% of the sum assured in the plan.
Moreover, if you surrender the ULIP policy before the lock-in period expiry, the tax benefit received is reversed, and the tax is deducted from your income in the year of policy surrender.
2. No tax on maturity benefit for annual premiums below ₹2.5 lakhs
As per Section 10(10D) of the Income Tax Act, all sum received in a ULIP, including the sum given as a bonus on the plan, is exempt from taxes if the total premium for the year is below ₹2.5 lakhs.
Before Budget 2021, the maturity benefits from ULIPs were tax-free as long as the premium paid did not exceed 10% of the sum assured in a year. However, with the Budget 2021-22, the gains on ULIP maturity payments for policies issued on or after 01.02.2021 will be taxed on par with Equity Mutual Funds. That implies, accounting for the ₹1 lakh exemption, ULIP maturity payouts will be taxed a 10% long-term capital gains tax. Additionally, Security Transactions Tax will be applicable on the redemption of the ULIPs.
You can use an online ULIP calculator to precisely know your premium amount. Not many tax-saving investments in India offer this benefit.
3. No tax on the death benefit
Since a ULIP is a combination of insurance and investment, the death benefit received is also tax-exempt. As per Section 10(10D) of the Income Tax Act, in case of your unfortunate demise, your nominee will get a death benefit along with the income generated from the ULIP investment component, which will be exempt from taxes in the hands of the nominee. This financial security will help your loved ones meet their expenses and maintain their standard of living in case of your absence.
4. No tax on top-ups
Most insurance companies allow you to buy additional top-ups to enhance your existing ULIP. Even these top-ups are exempt from taxes under Section 80(C) and 10(10D).
5. No tax on capital gains for annual premiums below ₹2.5 lakhs
Long-term capital gains of over ₹1 lakhs are taxed at 10% without indexation. Besides, short-term capital gains and long-term capital gains from debts are also taxed. However, ULIPs had the edge over such investments as they are exempt from both long and short-term capital gain tax. This implied that ULIP returns are tax-free.
That said, Budget 2021 has laid a cap on the tax exemption for new ULIPs that have an annual premium of more than ₹2,50,000. For ULIPs above this limit, there will be a long-term capital gain tax of 10%. Apart from this, all other tax exemptions of the ULIPs are still valid.
Summing Up
Despite the changes in the taxation structure, a ULIP policy is a great investment. You get tax savings of up to ₹1.5 lakhs for the premiums paid under Section 80(C). Similarly, the death benefits are tax-exempt under Section 10(10D). Additionally, you get the dual benefits of insurance + investment in a single policy.
With so many online ULIP plans in India, it has now become even more convenient to buy a ULIP investment that optimally aligns your investment goals and insurance needs.
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