Individual investors are always in search of investment arenas that will provide them with protection against future uncertainties and give high returns. Unit Linked Insurance Plan- ULIP is one such investment where a portion of your investment is put aside for securing your life and the rest is invested in funds that are equity-oriented, debt-oriented, or hybrid. Initially, Unit Trust of India (UTI) was the first ULIP introduced in 1971 followed by the Life Insurance Corporation (LIC) in 1989.
Hence, the ULIP plan is an efficient way to secure your future and build a corpus for yourself.
What is ULIP: Full Form and Meaning?
ULIP abbreviated as Unit linked Insurance Plan offers a perfect combination of financial planning as for any investor the two main concerns are:
- Insurance (Term & Medical)
- Equity investment
ULIP plan helps satisfy both the concerns mentioned above. Moreover, the investor can claim the deduction under Section 80C. Insurance Regulatory and Development Authority (IRDA) of India regulates ULIP plan.
In the budget 2021, the Finance Minister announced that proceeds from the ULIP plan (amount receivable at the time of maturity of the policy) will be taxable if the annual premium exceeds INR 2.5 lakh in any given year of the policy’s term.
How it Works?
As we know, ULIPs offer life insurance coverage along with an opportunity to invest in a variety of market funds including stocks, debt, or a combination of both. The premium paid towards the policy is invested in such funds according to the risk appetite of the investor.
Once you purchase a ULIP plan, the insurance firm invests a portion of your money into equity markets while the remaining amount is set aside to provide insurance coverage. There are fund managers who keep track of the investment.
ULIPs gives the flexibility to switch between debt and equity-oriented portfolio and so policyholder can maximize their returns by switching between their investments when the market conditions are favorable.
What is the Lock-in Period?
The lock-in period of ULIP is usually 5 years. However, the policyholder should at least hold the policy for 15 years or more as ULIP is a combination of insurance and investment and both of them are considered a long-term investments.
What are the different types of ULIPs?
In India, there are various types of ULIP plans that are available which cater to a wide range of audiences based on their risk appetite and end investment objective. Below are mentioned ULIPs based on such criteria:
ULIPs Based on Funds
- Equity-Oriented Funds: Under these ULIPs, the investment is majorly in high-risk equities.
- Debt-Oriented Funds: Here, ULIPs invest in debt instruments such as debentures, corporate bonds, Government bonds, securities, and fixed-income bonds.
- Balanced Funds: These Unit Linked Insurance Plans are a combination of both equity and debt. Here the investments are made partly in equity-oriented funds and partly in fixed-income debt instruments.
- Cash Funds: These are the ULIPS where the investment occurs in cash and bank deposits, money market funds, and other money market instruments.
Based on Creating Wealth
- Guarantee/Non-Guarantee: The main aim of Guaranteed ULIPs is capital preservation. Therefore, a small proportion is invested in equities, to avoid market risk. Under Non-Guarantee, the main aim is to maximize wealth creation and therefore, a large proportion is invested in the equity market. Hence, non-guarantee ULIPs have larger yields but are riskier as a result.
- Single-Premium and Regular Premium: Under single-premium ULIPs, an investor has to pay the premium only once. This takes place during the time of purchase. On the other hand, for regular premium ULIPs, you have to pay the premium monthly, quarterly, semi-annually, or annually as you choose to do so.
- Life Stage based: Life-staged ULIPs operate with the thought process that the risk appetite of individuals reduces as they grow old. Hence, ULIPS under these categories increase their investment in debt instruments and reduce the proportion of investment in equity-oriented funds as the investors grow old.
Based on the End Use of the Fund
- Wealth Creation: This type of ULIP helps in creating a corpus of funds that you can use to fulfill your future financial goals.
- Funding Children’s Education: Investing under these schemes ensures the future needs of your children and other unforeseen circumstances.
- For Retirement: Retirement-centred ULIPs are those which focus on building a corpus that you can utilize during your retirement.
Taxation on ULIPs
Premiums paid towards ULIP are eligible for deduction under section 80C up to a maximum of INR 1.5 lakhs during a financial year.
Although, before the announcement of the Union Budget 2021, ULIP used to fall under the EEE (Exempt, Exempt, Exempt) category. However, the FM proposed certain changes which will affect the taxation of ULIP. Below are the major changes:
- The total or annual premium that is payable towards ULIP that is not extending INR 2,50,000 are only eligible for the EEE category.
- There is a capital gains tax that is proposed for ULIPs similar to equity-oriented mutual funds, where a tax will be levied at 10% on returns exceeding INR 1,00,000. This will apply to ULIPs that are not covered above and subscribed to on or after February 1, 2021. (Since the lock-in period is more than 12 months, LTCG will be levied on ULIPs)
- Security Transaction Tax (STT) is also proposed to be levied on unit-linked insurance plans issued by such insurance companies on or after February 1, 2021. This STT will be levied on the sale or surrender or redemption of a unit of an equity-oriented fund to the insurance company, on maturity or partial withdrawal.
The below table summarizes ULIP taxation before and after the 2021 budget announcement:
Example of taxability on ULIP
Case: On April 1, 2022, Ankit purchased a ULIP policy assuring a sum of INR 25 lakhs on which he pays a premium of INR 2 lakhs every year during the term of the policy. On June 1, 2022, he purchases another policy assuring a sum of INR 10 lakhs on which he pays a premium of INR 1 lakh every year during the term of the policy.
Solution: Ankit has purchased two ULIP policies, both after February 1, 2021 hence, the maturity proceeds of the policies will be exempt u/s 10(10D) only if the premium paid for a single policy as well as the aggregate premium paid on both the policies do not exceed INR 2,50,000 in any year during the term of the policy.
|Policy||Premium||Taxability on the Maturity Proceeds|
|Policy 1 (01/04/2022)||2 lakh||Exempt u/s 10(10D)|
|Policy 2 (01/07/2022)||1 lakh||Net income taxable under Capital Gains|
Note: Ankit gets an option to choose to avail of exemption in respect of any one of the two policies as an exemption in respect of both policies cannot be availed because the aggregate premium exceeds the limits specified. Hence, It is advisable to claim the exemption in respect of the first policy as the maturity proceeds (i.e. INR 25 lakhs) are higher than the maturity proceeds of the second policy (i.e. INR 10 lakhs).
What are the Benefits of Investing in ULIP?
Investing in ULIPS can have many advantages, some of which are as follows:
Life Insurance: ULIPs provide life insurance coverage along with investment opportunities. This is a dual advantage you can claim from this policy.
Flexibility: In order to deal with the ever-changing market conditions, the design of ULIPS takes place in a manner where the investor has the option to switch between equity or debt depending upon the market volatility and risk appetite.
Long-Term Goals: ULIPs have a lock-in period of 5 years hence it helps in achieving long-term goals like children’s education, marriage, or buying a car or house. Additionally, individuals who invest in ULIP generally invest for a longer period of time in order to reap the benefits of the market.
Tax benefits: You can claim a deduction under section 80C on the premium amount paid up to INR 1.5 lakhs.
ULIP vs Mutual Fund
Mutual funds and ULIPs have long been regarded as two of the better-performing assets for wealth creation. A comparison between ULIP & Mutual Funds is shown below:
|Scope||Investment as well as insurance product||Investment product|
|Withdrawal||There is a lock-in period of 5 years as it is a long-term investment||Can be withdrawn anytime|
|Liquidity||Limited liquidity||High liquidity|
|Tax Benefit||Tax deduction can be claimed under section 80C||No tax benefits|
|Switching between funds||Altering between funds is permissible||Switching is not permissible; the only way to reduce the risk is to exit which may incur tax on capital gains|
ULIP vs ELSS
|Tax Benefit||A deduction can be claimed under section 80C||A deduction can be claimed under section 80C|
|Taxation||Gains more than INR 1 lakh in a given financial year is taxable under LTCG @10%||Gains more than INR 1 lakh in a given financial year is taxable under LTCG @10%|
|Lock-in period||5 Years||3 Years|
|Risk||High Risk||Moderate Risk|
|Underlying Asset||Equity, Debt, and Balanced||Equity|
|Charges||Below are the major charges associated with ULIP:|
Mortality Charge, Premium Allocation Charge, Switching Charge, Surrender Charge, Policy Administration Charge, etc.
|Charges are simple and easy to understand:|
Approximately, on an average Expense Ratio ranges from 1.05% to 2.25%
The lock-in period in Unit linked Insurance Plan is 5 years.
If an individual changes their mind then usually there is a free look-in period of 30 days.
Yes, investors are given the freedom to change from one fund to another at any point in time.
Yes, if an individual fails to pay the premium within the first 3 years of the policy, insurance cover is immediately discontinued. For premiums not paid after 3 years, the surrender value is paid and the contract is terminated.
Yes, one can surrender their ULIP after paying the surrender charges.
Yes, a Top-up facility is provided but it depends on the features of the ULIP scheme that you have availed.
Let’s understand ULIP Taxation better with the help of some more examples.
On March 1, 2012, Mr. Patel purchased a ULIP policy assuring a sum of ₹20,00,000, on which he paid a premium of ₹3,00,000 every year during the term of the policy. He received the maturity amount on March 31, 2022. What shall the tax implications?
Mr. Patel purchased the policy on March 1, 2012, i.e, before April 01, 2012. Since the premium paid by him (i.e. ₹3,00,000) is less than 20% of the sum assured (i.e. ₹4,00,000), the maturity proceeds of ₹20,00,000 received by him will be exempted u/s 10(10D) and no tax will be levied on the same. He is also eligible to claim a deduction u/s 80C up to ₹1,50,000.
Mr. Kapoor purchased a ULIP policy on June 30, 2012, and paid a premium of ₹2,00,000 every year during the term of the policy, on a sum assured of ₹15,00,000. He received maturity proceeds of the same on June 30, 2022. What shall the tax implications?
Mr. Kapoor purchased the ULIP policy after April 01, 2012.
Here, the premium paid (i.e. ₹2,00,000) exceeds the limit of 10% of the sum assured (i.e. ₹1,50,000), hence the maturity proceeds received by him will be taxable under the head Income from Other Sources and taxed at slab rates. He is also eligible to claim a deduction u/s 80C up to ₹1,50,000.
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