From 2018 to 2021, ULIPs had become the favorite of many (mostly HNIs) because of the exclusive tax-free status they enjoyed when compared to the then-newly announced LTCG taxation of mutual funds. But this was changed in 2021 when the Budget 2021 announced that Unit Linked Insurance Plans (ULIPs) will now also be taxed.
As per the new rule about ULIP taxation – If you buy a ULIP with an aggregate annual premium that exceeds Rs 2.5 lac in a financial year, then the maturity proceeds (or any form of pay-out except death benefit) from such ULIP will be taxable. Do note that this rule came into effect on 1st February 2021 and older ULIPs purchased before that day were not affected by this rule change.
Let me take a few examples to help you understand this:
- You purchased ULIP Insurance in 2017 and are paying Rs 5 lakh towards the annual ULIP premium – Any pay-outs from the ULIP will continue to be exempted from tax as long as the Sum Assured is more than 10 times the annual premium.
- You purchased a ULIP in 2017 and are paying Rs 5 lakh towards the annual ULIP premium. You again purchased a new ULIP in March 2021, with a premium of Rs 2 lakh – Any payout from the old ULIP will continue to be exempted from tax. Also, the payout from the new ULIP will be tax-exempted as it’s less than the Rs 2.5 lakh threshold for activation of the new tax rule.
- You purchased a ULIP in 2017 and are paying Rs 5 lakh towards the annual ULIP premium. You again purchased a new ULIP in August 2021, with a premium of Rs 6 lakh – Any payout from the old ULIP will continue to be exempted from tax. But the payout from the new ULIP will be taxable as it’s more than Rs 2.5 lakh.
Note: Irrespective of when the ULIP is purchased or what is its premium, i.e. for both old ULIPs and new ULIPs, the death benefit will be exempt from taxes.
We all know ULIP is a hybrid product that offers both investment and insurance. And till recently, it was a popular product among HNIs due to the tax advantage it had over mutual funds. Before the rule change, the investors were allowed to switch between equity and debt without any tax incidence in the middle and this was the main advantage of the ULIPs. But with the rule change for high premium ULIPs, there is no way to go for tax-free rebalancing for HNIs via ULIPs now. Even the government-backed LIC has many ULIPs and surprisingly, one named SIIP from LIC to make it sound similar to mutual fund SIP.
Though I am not in favor and I tell everyone to do not mix insurance and investments, ULIPs are still better than traditional endowment or moneyback plans from insurance companies. And I am sure that you know why. I have written about it several times and hence, don’t think it requires repetition.
If you are considering ULIPs for life insurance*, it’s better to do it via plain and simple term plans. You can get a Rs 1 crore term plan for just a few thousand rupees if you aren’t very old.
* Read more about how different life insurance options are taxed in India.
If you are considering ULIPs as investments, then there are mutual funds that do not have high expenses that are part of ULIPs due to their various charges. If you have some very unique need that requires a combination of the two, and you know how ULIPs are structured and how they charge their investors, only then get into it. And if you do so, then keep these things in mind when purchasing a ULIP package online:
- Consider your financial objectives – Because ULIP plans are flexible, you may direct where your money is invested. When you buy a ULIP, you are given a list of funds that invest in debt, equity, or a combination of the two. The first step in any guide to picking a ULIP plan is to ensure that you understand your life objectives and financial demands so that you can buy a ULIP plan online that meets those criteria.
- Select adequate investment term – Like any other product, here also you need to stay invested for a long to get the power of compounding to maximize your gains. While buying a ULIP scheme available on the internet, you are given a 5-year lock-in period. Based on the policy provisions, a surrender value may be received after three years, and provisional withdrawals may be permitted after five years. But inspite of the exit option availability, staying invested for long is the way to go, just like it is mutual funds.
- Consider the charges levied – It is pivotal that you invest your money with your eyes wide open so you know exactly what you will be getting into and what you stand to gain when you buy a ULIP plan online or offline. Insurers levy specific charges common to all ULIPs under the headings of fund management fees, mortality charges, service charges, administration fees, premium allocation charges, discontinuation or surrender charges, etc. Some insurers levy all of these charges, while others do not. Make a well-informed choice after considering the charges when you buy ULIP online.
That’s it. But if you still have doubts about whether you need ULIPs or not, then please get in touch with a good investment advisor who can plan your finances properly and decide where you should invest in ULIPs or not.
Note – Do read my column in Morningstar about ULIPs here.
So that was about the taxation of ULIPs in India (2023).