ULIP Taxation

 

What is a ULIP?

ULIP (Unit Linked Insurance Plan) is an insurance cum investment plan that offers the dual benefits of a life cover and market linked investment plan. The life is to financially protect your family in the event of your unfortunate demise, while the investment is to achieve your and your family's long-term goals. But how does ULIP provide these twin benefits? Well, the premium you pay gets divided into two portions. A part of your premium is paid to your life insurance cover, whereas the other is invested in the fund of your choice. Depending on your financial needs or goals (such as retirement planning or a child's higher education) & risk tolerance, you can invest in debt, equity, or both.

In the case of ULIP, you, as a policyholder, are spared the headache of monitoring the investments because fund managers of India's largest insurers, such as HDFC Life, handle all that for you. ULIPs enable you to change the balance of your portfolio between debt and equity according to your risk tolerance, changes in financial situation, and understanding of the stock market.

Tax on ULIPs: Key Considerations

• Tax Benefits of  payment of  ULIP premiums

Premium paid towards ULIPs can be claimed as a tax deduction under Section 80C of the Income Tax Act up to the overall limit of Rs 1.5 lakh per year.

• Tax implications on ULIP withdrawals

If you withdraw from the ULIP policy before the expiry of its five-year lock in period, the surrender value is treated as income and therefore taxed as per your applicable income tax slab. Also keep in mind that the Tax Deducted at Source (TDS) too will be applicable on that surrender value of ULIP  if the premium is exceeding 10% of the sum assured.

• Taxation of ULIP maturity proceeds

If you had paid ULIP premium of Rs 2.5 lakh or more for a policy purchased on or after 1st February 2021, then the returns on that ULIP, i.e. the maturity amount received (including bonus), would be taxable. Long term capital gain (LTCG) tax of 10% on gains above Rs 1 lakh shall be applicable.

However, the maturity amount received upon the policyholder’s death is tax free. The death benefit remains exempt from any tax under Section 10(10)D of Income Tax Act.

Also, if your ULIP was issued on or after 1st February 2021 with an annual premium of less than Rs 2.5 lakh, then also the maturity benefits are tax-free provided the annual premium does not exceed 10% of the  sum assured.

ULIP Tax Benefits

• Eligibility for ULIP taxation benefits under Section 80C of the Income Tax Act

The biggest ULIP tax benefit is of its premium payment. The insurance premium paid towards ULIPs can be claimed as a tax deduction under the Section 80C of Income Tax Act, upto the overall limit of Rs 1.5 lakh per year.

• Tax exemption on ULIP death benefits u/s 10 (10D)

No matter how much premium you paid for ULIP, the maturity amount received upon the policyholder’s death is fully tax free. The death benefit remains are exempt from any tax on ULIP under Section 10 (10D) of Income Tax Act.

• Is ULIP Tax-Free?

The answer depends upon your ULIP premium amount and the date when you purchased it. ULIP is fully tax-free if your ULIP was issued on or after 1st February 2021 with an annual premium below Rs 2.5 lakh and premium is not exceeding 10% of the  sum assured. If you had paid a ULIP premium of Rs 2.5 lakh or more for a policy purchased on or after 1st February 2021, then the returns on that ULIP, i.e. the maturity amount received (including bonus), would be taxable.

Also, returns on all ULIPs purchased between April 2012 to February, 2021 are completely tax free if the premium was less than 10% of sum assured. For ULIPs purchased before April 2012, the maturity amount was tax free if the premium was less than 20% of sum assured for that policy.

ULIP Taxation Rules and Implications

• Premium Payment Tax Benefits

The insurance premium paid towards ULIPs is eligible for an income tax deduction under Section 80C of the Income Tax Act, up to the total limit of Rs 1.5 lakh per year.

• Maturity Proceeds Taxability

ULIP is totally tax-free if your policy is issued on or after 1st February 2021, with an annual premium of below Rs 2.5 lakh and premium is not exceeding 10% of the  sum assured . If you had paid a ULIP premium of Rs 2.5 lakh or more for a policy purchased on or after 1st February 2021, then the returns on that ULIP, i.e. the maturity amount received (including bonus), would be taxable.

Moreover, keep in mind that returns on all ULIPs purchased between April 2012 to February 2021 are completely tax-free if the premium was less than 10% of the sum assured. For ULIPs purchased before April 2012, the maturity amount was tax-free if the premium was less than 20% of the sum assured.

• Death Benefit Tax Exemption

The maturity amount received upon the policyholder’s death is tax free. The death benefit remains exempt from any tax under Section 10(10)D of Income Tax Act.

• Withdrawals/Surrender Tax Implications

In case you withdraw the ULIP before the expiry of its five-year lock-in period, the surrender value is treated as income and, therefore, taxed as per your applicable income tax slab. Also keep in mind that the Tax Deducted at Source (TDS) too will be applicable on that surrender value of ULIP if the premium is exceeding 10% of the sum assured.

ULIP Tax Planning Strategies

Here are some effective strategies to help you optimise your ULIP tax planning:

• Maximise The Benefits Available Under Section 80C

The biggest tax benefit for ULIPs is that the premium paid is eligible for upto Rs 1.5 lakh annual deduction under Section 80C. Maximise this tax benefit as it can significantly minimize your tax for that financial year.

• Utilise The Tax-Free Maturity

Other than the ULIP plans whose premiums are Rs 2.5 lakh or more annually and were purchased after 1st February 2021, all other ULIP plans have a tax free maturity provided the premium did not exceed the specified percentage of sum assured. So make sure you are aware of this benefit and whether your ULIP is eligible for it.

• Use The Fund Switching Facility Wisely

Also, make sure to utilise the ULIP's fund-switching facility to move to funds that offer better efficiency for tax on ULIP.

• Tax on ULIP

Let us bring to you three examples to help you understand ULIP taxation.

Example-1:

Aman and Boney purchased ULIP plans.  with sum assured  of Rs 15 lakh and Rs 30 lakh. The maturity period was 10 years, and the annual premium paid by Aman was Rs 85,000, and for Boney, Rs 2.6 lakh.

Then after 10 years, the maturity proceeds that Aman received was Rs 20 lakh, while Boney got Rs 48 lakh.

Now, as Boney's annual premium exceeds Rs 2.5 lakh, he has to pay tax on the returns, i.e. Rs  22 lakh (Rs 48 lakh-Rs 26 lakhs). However, Aman would be eligible for an exemption under Section 10(10D) since his annual premium was Rs 85,000.

Now, let us take another example to understand ULIP taxation more deeply.

Example-2:

Simran purchased a ULIP plan on 1st April 2021, involving Rs 2.5 lakh annual premium and Rs 25 lakh sum assured. Assuming the consideration received on 1st November 2031 turns out to be Rs 32 lakh, this amount shall be exempt u/s 10 (10D) since the annual premium Simran paid is not above Rs 2.5 lakh.

Example-3:

Manoj had bought a ULIP plan with a premium of Rs 3 lakh annually, sum assured Rs 40 lakhs and a tenure of 20 years. The maturity proceeds for Manoj turned out to be Rs 65 lakh, implying a Rs 5 lakh profit. Here, the LTCG tax of 10% shall be levied on gains exceeding Rs 1 lakh, i.e. on Rs 4 lakh, implying LTCG tax of Rs 40,000.

Conclusion

It's a no-brainer that investors seeking good returns and, at the same time, wishing to protect their family's financial future with a life cover, can go for ULIPs. With tax-free maturity in most cases, fully tax-free death benefits, and tax benefits u/s 80C for the premium paid, ULIPs do turn out to be an attractive scheme for those looking to grab the twin benefits of the investment plan and insurance cover. Just make sure you are aware of ULIP tax rules and benefits so as to maximise them.

FAQs on Ulip and Taxes

Q. Are ULIP premiums tax-deductible?

The insurance premium paid towards ULIPs is eligible for a tax deduction under Section 80C of the Income Tax Act, up to the total limit of Rs 1.5 lakh per year.

Q. What are the tax implications if I surrender my ULIP policy?

If you surrender the ULIP policy before the expiry of its five-year lock-in period, the surrender value is treated as income and, therefore, taxed as per your applicable income tax slab.

Also keep in mind that the Tax Deducted at Source (TDS) too will be applicable on that surrender value of ULIP if the premium is exceeding 10% of the sum assured. .

Q. Is the maturity amount from ULIPs taxable?

Tax on ULIP is totally absent if your ULIP was issued on or after 1st February, 2021 with an annual premium of less than Rs 2.5 lakh and premium not exceeding 10% of the sum assured. If you had paid a ULIP premium of Rs 2.5 lakh or more for a policy purchased on or after 1st February 2021, then the returns on that ULIP, i.e. the maturity amount received (including bonus), would be taxable.

Moreover, keep in mind that returns on all ULIPs purchased between April 2012 to February 2021 are completely tax-free if the premium was less than 10% of the sum assured. For ULIPs purchased before April 2012, the maturity amount was tax-free if the premium was less than 20% of the sum assured.

Q. What is the lock-in period for ULIP?

To encourage long-term investment, the minimum lock-in period for a ULIP is set at five years.

Q. What is the switch option?

As its name suggests, the 'switch' facility under ULIP enables you to move your money between equity and debt funds and vice versa. This can be done if your financial goals or risk appetite change during the policy tenure.  Usually, a specified number of switches. Like 2 or 3, are allowed for free by insurers; a fee can be charged if the number of switches goes beyond that specified mark.