The Union Budget 2021-22 has removed the disparity between taxation of ULIPs and mutual funds. At least to a very large extent.
The Budget 2021 has withdrawn the tax-free status for maturity amount on fresh ULIP purchases if the annual premium exceeds Rs 2.5 lakh in any year.
The new taxation norms for ULIPs will become applicable immediately, i.e. from 1st February 2021.
That is, from 2021 onwards, if you buy a ULIP with an annual premium of more than Rs 2.5 lakh, then the maturity proceeds of the ULIP will be taxed in a fashion similar to mutual funds.
So any capital gains made on such ULIPs will now attract short-term capital gains (STCG) or long-term capital gains (LTCG) tax at redemption or maturity at par with other equity-oriented investments.
- So the long-term capital gains tax in equity-oriented ULIPs (applicable after 1 year) will be 10% on the amount exceeding Rs 1 lakh per financial year and the short-term capital gains tax will be 15%.
- On the other hand, the long-term capital gains tax in debt oriented ULIPs (applicable if the holding period exceeds 3 years) will be 20% with indexation and the Short-term capital gains tax will be taxed at the marginal rate of taxation.
Read more about mutual fund taxation in India to know more.
As for the death benefit, it continues to remain tax-free regardless of the annual premium amount.
Or put in other words, the tax benefits will still remain in the event of death of the life assured or in the case of ULIPs where annual premium is below Rs 2.5 lakh.
Till now, the maturity proceeds from a life insurance policy were tax-free. This is because the Clause (10D) of section 10 of the Act provides for the exemption for the sum received under a life insurance policy, including the sum allocated by way of bonus on such policy in respect of which the premium payable for any of the years during the terms of the policy does not exceed ten per cent of the actual capital sum assured. With the new ULIP related announcement, the exemption under this clause shall not apply with respect to any ULIP if the amount of annual premium payable for any of the previous years during the term of the policy exceeds Rs 2.5 lakh.
Important: It still makes sense to keep insurance and investments separate. That is, for insurance, its best to go for simple term insurance plans.
Also, the new announcement is related to ULIPs only. The maturity benefits of traditional insurance plans like endowment plans and money-back policies still remain tax exempt.
I think this will reduce mis-selling of ULIPs going forward. At least to some extent. There were instances where ULIPs with huge premiums were sold to high net worth individuals claiming tax exemption under this tax-free maturity clause (or because of the tax advantage offered on the maturity amount or gains).
Further reading: ULIP vs Mutual Funds: ULIPs lose tax arbitrage