How taxation of ULIPs has changed
Going forward, if the annual premium of your new ULIP investment is more than Rs 2.5 lakh the return that you will get will no longer be tax exempt. “Tax exemption shall be available under Section 10(10D) only for maturity proceed of the ULIPs having annual premium up to Rs. 2.5 lakh” says Kapil Rana, founder & chairman, HostBooks, a tax compliance solution provider.
“In case of ULIPs having annual premium more than Rs 2.5 lakh the income/return on maturity shall be treated as capital gain and charged accordingly under section 112A, however the cap of Rs. 2.5 lakh on the annual premium of ULIP shall be applicable only for the policies taken on or after 01.02.2021” he adds.
The new taxation rule will apply only on new ULIPs so you do not need to worry about your existing ULIPs where you can keep investing the premium till maturity of the policy. However, in case of new ULIPs, buying multiple policies will also not help. “If premium is payable for more than one ULIP, the aggregate premium for such policies should be considered to compare with threshold of Rs 2.5 lakh” says Tapati Ghose, Partner, Deloitte India.
The new tax treatment of ULIPs with premium above Rs 2.5 lakh
As the new tax proposal makes the treatment of ULIPs which do not enjoy tax exemption similar to equity mutual funds so the question arises as to what will happen to the debt investments under ULIPs.
Some experts are extrapolating the proposal to mean that the debt fund/investment portion in ULIPs could be treated the same as equity mutual funds. “The definition of ‘Equity-Oriented Fund’ in Section 112A is proposed to be amended by the Finance Bill, 2021. It is proposed to cover ULIPs to which exemption under Section 10(10D) does not apply on account of the applicability of the fourth and fifth proviso thereof. Thus, the high premium ULIPs shall be considered as Equity Oriented Fund even if a portion of the fund is invested in the debt-based scheme. The said meaning of Equity Oriented Fund also applies for Section 111A” says Naveen Wadhwa, DGM, Taxmann.
“In other words, the long-term capital gains, in excess of Rs. 1,00,000, shall be taxable at the rate of 10% without indexation under Section 112A. Whereas the entire amount of short-term capital gains shall be taxable at the rate of 15% under Section 111A. The ULIPs shall be considered as a long-term capital asset if they are held for more than 12 months and short-term capital assets if held for 12 months or less” adds Wadhwa.
Another aspect which investors want clarified is what will happen in case of switches from debt to equity or vice versa in the same ULIP. “No tax implications would arise on such switching from one fund to the other provided the maturity/redemption of units of ULIPs are exempt under Section 10(10D). If no such exemption is available for the excess premium or high-premium policies, such switching between the funds may be taxable under the head capital gains. However, the CBDT should provide clarity on this aspect” says Wadhwa.
While this may be one interpretation there are other divergent opinions also so a clarification from tax authorities is required to clear the picture. “Currently, there seem to be no specific proposals to deal with manner of taxation of switches / redemptions of funds in a ULIP that do not meet the definition of equity-oriented funds. So, we should wait for detailed rules to come” says Ghose.
Next area which needs clarification from tax authorities is treatment of surrender or partial withdrawal after completion of 5 years of lock-in period. “As per my opinion, any surrender value where the annual premium of ULIP is more than Rs 2.5 lakh for the policy taken on or after 01.02.2021 should be charged as long term capital gain under section 112A with an exemption up to Rs 1 lakh, or tax treatment of surrender value would remain unchanged i.e. surrender value shall be added with other income and taxed according to the applicable slab rates” says Rana of Hostbooks.
“After new tax changes, we need more clarification on the tax treatment of surrender value received after completion of 5 years lock-in period as partial premature withdrawal of the policy where the annual premium of ULIP is more than Rs 2.5 lakhs and the policy is taken on or after 01.02.2021” he adds.
Less room for LTCG tax saving maneuvers
One can churn one’s investments (buy-sell) in equity MFs to generate long term capital gains to regularly exhaust the annual Rs 1 lakh tax exempt limit but there is no such advantage in ULIPs Though you can get exempted redemption after first five years of lock-in, but if you re-invest it in same ULIP over and above the regular premium, the aggregate annual premium may go above 10% of the sum assured and hence the returns will no longer be exempted under section 10(10D).
To continue enjoying the 10(10D) exemption despite higher premium you will need to buy a ULIP with much higher insurance cover so that aggregate premium does not go beyond the limit of 10% of the sum assured. However, the additional cover is undesired and will come at additional cost which will bring down the net return.
Where ULIPs remain attractive
ULIP premium enjoys the section 80C deduction benefit upto Rs 1.5 lakh per annum. Besides, if your annual premium remains below Rs 2.5 lakh you would continue getting tax free return under section 10(10D). If you invest Rs 20,833 per month for next 15 years and get a net return of 12% your funds will grow to Rs 98.22 lakh. This may be sufficient for a large section of investors for many long-term life goals like children’s higher education and marriage.
Both ULIPs with premium below Rs 2.5 lakh and those with higher premium will give tax free return to the beneficiary in case of unfortunate demise of the investor. “In case of the unfortunate death of the insured person, his/ her family will receive life insurance cover or the prevailing fund value, whichever is higher. This death benefit is tax-free under Section 10(10D) of the Income Tax Act, 1961” says Karthik Raman, CMO & Head – Products, Ageas Federal Life Insurance.
However, in case of the equity mutual funds the return will not be exempted from tax. “In case of Equity-Oriented MF, the proceeds shall be taxable in the hands of the legal representative or legal heirs, as the case may be” says Wadhwa.
People who are new to equity investment and looking for a consolidated structured product may find ULIPs simpler to understand and convenient to invest. “It offers a hassle-free experience in managing financial goals through a single window. It also gives policyholders the opportunity to invest across Equity and Debt funds through a single plan which helps in efficient long-term wealth creation in a dynamic market scenario” says Aneesh Khanna, Executive Vice President – Product, HDFC Life.
New generation Online ULIPs are competitive in cost
ULIPs originally got a bad name due to exorbitant charges and miss-selling practices around the end of the first decade 2000-10. The insurance regulator IRDA made concerted efforts to get rid of these shortcomings and put investors’ interest at the front. Insurers restructured their ULIPs to cater to the cost-conscious investors segment. New ULIPs especially the ones offered online have gone through significant transformation in terms of cost to remain competitive with mutual funds.
“New generation ULIPs are designed taking into consideration the emerging consumer needs and have a more efficient cost structure. The charges are primarily built around the cost of mortality and fund management and are therefore leaner and similar to the overall cost structure of Mutual Funds” says Khanna of HDFC Life.
Should you buy ULIPs now?
Many experts advise investors to avoid ULIPs and go for a combination of term insurance and equity MFs. “A mutual fund portfolio adjusted for one’s risk and goals for investments along with a straightforward term-plan provides you best of both worlds – wealth creation and risk cover” says Eela Dubey- Founder of EduFund.
When it comes to liquidity, ULIPs being a long-term goal driven product cannot compete with MFs. “While inter scheme switches within a policy have no exit or tax load, still the opaque structure, long tenure, compulsory 5 year minimum contributions and lock-in make a ULIP unsuitable” says Col Sanjeev Govila (Retd), a SEBI Registered Investment Advisor (RIA), and CEO, Hum Fauji Initiatives, a financial planning firm.
However, while the equity MF option may work well for savvy investors, a lay investor runs the risk of ending up with a wrong investment. All equity mutual funds are not a safe ticket to high returns as a good number of them are unable to deliver and beat their benchmarks. The universe of equity mutual fund is quite big, and it becomes difficult for a lay investor to pick the right funds.
Unless the investor is savvy enough to pick the right funds suiting his risk appetite or gets paid advisory services it is difficult to be sure about the fund selection. When it comes to ULIPs the fund options are limited which makes fund selection simpler.
If you are investing within Rs 2.5 lakh annual premium limit the gain in terms of tax saving remains attractive. To beat the post-tax net return from a ULIP, an equity MF would have to give a much higher net return as an equity MF investor will have to pay a 10% LTCG tax on LTCG of above Rs 1 lakh.
ULIPs are not meant to give you adequate insurance cover which should ideally be taken through a good term plan. Even when you take a good amount of cover via a pure term plan at the time of marriage you may need to upgrade it after few years when you welcome a new baby in the family or when your income goes up substantially or you add a big liability like a home loan. If it comes to investing for special purposes like child’s future or your own retirement, a ULIP with desired insurance cover upgrade may work as goal protection tool.
“Child-ULIPs offer a waiver of premium benefit in case of the unfortunate demise or disability of the policyholder, while there are certain ULIPs which also offer critical illness benefits and health riders. These riders make a ULIP a powerful asset in terms of the financial security it extends to the investor, which a MF doesn’t offer” says Raman of Ageas Federal Life Insurance.
ULIPs optimize your insurance cost as you pay mortality premium on Sum-at-risk, which gradually comes down as your investment accumulates and grows resulting in decreasing sum-at-risk. While in a term plan you continue paying the same premium even when your insurance need comes down due to asset accumulation over years and increase in net worth.
“All investors should evaluate investing in ULIPs before taking their final decision. While the new guidelines announced in the Budget make big ticket cases taxable, investors can still look at investing in ULIPs with smaller ticket sizes” says Raman.
