Unit Linked Insurance Plans (ULIPs) have long been a popular investment choice for their dual offering of life insurance and market-linked returns. However, the ULIP taxation rules have evolved over time, especially with significant changes introduced in the Union Budget of 2021. These changes have affected how ULIP investments are viewed from a tax perspective. Let’s look at the transition of ULIP tax rules from before and after the premium capping brought about by Budget 2021.
Before Budget 2021**
1. Tax Benefits on Premiums Paid:
Before Budget 2021, ULIP taxation rules allowed premiums paid towards ULIPs to be eligible for deduction under Section 80C of the Income Tax Act, 1961 (Act). The maximum permissible deduction under this section was ₹1.5 lakh per financial year. This deduction is applicable only if the premium does not exceed:
- 10% of the sum assured (policy taken on or after 01/04/2012)
- 20% of sum assured (policy taken up to 31/03/2012)
- 15% of sum assured (policy taken on or after 1/04/2013 by person who is disable or suffering from severe disease.
This made ULIPs an attractive instrument not only for the benefits of financial protection and wealth creation but also for significant tax advantages. By availing of Section 80C, investors effectively reduced their taxable income, thus diminishing their overall tax liability.
2. Tax-Free Maturity Proceeds:
In terms of maturity benefits, ULIPs had a distinct advantage. The maturity proceeds from a ULIP were fully exempt from tax under Section 10(10D) of the Act subject to satisfaction of various conditions laid down under the provisions of the Act.. This exemption meant that upon the policy’s maturity, the policyholder could enjoy the entire corpus without any deductions. Such tax-free benefits added to the appeal of ULIPs, making them a favourable choice for long-term investment and life coverage.
After Budget 2021**
The Union Budget of 2021 introduced a new change in the tax rules for ULIPs, primarily through the imposition of a premium cap.
1. Taxation Based on Premium Amount:
A significant change brought about by the Budget was the taxation of ULIP maturity proceeds, conditional upon the annual premium amount. If the cumulative premium across all ULIPs held by an individual exceeded ₹2.5 lakh, the maturity proceeds would no longer be tax-exempt under Section 10(10D) of the Act. The application of this taxation rule would only be for ULIPs purchased on or after February 1, 2021. This new rule introduced a distinction between high premium values and moderate premium values in ULIPs.
2. Capital Gains Tax:
These revised new ULIP rules meant that for investors with premium payments exceeding ₹2.5 lakh annually, the returns on the maturity of such ULIPs would be subject to capital gains tax.
Specifically:
- For equity-oriented funds within ULIPs, the applicable tax would be a Long-Term Capital Gains (LTCG) tax at the rate of 12.5% , applicable on gains exceeding ₹1.25 lakh.
- For other than equity oriented fund within ULIP, the taxation would follow the criteria and rate of tax as that of debt-oriented ULIP funds, depending on the period of holding, the proportion of debt involved in the fund etc
These changes aligned the taxation of certain ULIPs more closely with mutual funds, impacting investors’ decisions on high-premium ULIPs.
The retention of benefits under the 2.5 lakh capping of ULIP ensured lower-premium policies continue to provide the dual tax advantages that attracted investors before 2021. This aspect of the new ULIP taxation rules, maintains ULIPs as a viable investment option for individuals focused on tax-efficient, moderate-premium investments.
After Budget 2025**
In order to rationalize the taxation of ULIP pursuant to the amendment vide Finance Act, 2021, it is proposed vide Finance Bill 2025 that:
- ULIP products not fulfilling the basic conditions prescribed under section 10(10D) of the Act will be classified as “Non-exempt ULIP” and accordingly, categorized as “Capital Assets” under section 2(14) of the Act.
- Any gains/profits arising from redemption of such Non-exempt ULIPs will be taxable under the head “Capital Gains” as per the computation mechanism prescribed under the provisions of the Act.
- Further, such non-exempt ULIPs will form part of the “Equity Oriented Fund” as defined under the provisions of the Act.
Investment Advice for ULIPs**
The evolution of a ULIP’s taxation rules reflects a broader move towards more defined and equitable taxation laws. The distinction based on premium limits before Budget 2021 strives to ensure that high-premium investors contribute more equitably to the tax pool. Meanwhile, retaining tax advantages for policies with premiums up to ₹2.5 lakh promotes savings and investment among various income groups.
An investor must understand these new ULIP rules and align their investment strategy accordingly:
- Whether you favour ULIPs for their insurance benefits, investment growth, or tax efficiencies, staying informed about the tax implications can optimize your financial planning.
- The recent changes in ULIP taxation rules necessitate a careful assessment of investment strategies, especially for high-net-worth individuals who may be affected by the ₹2.5 lakh threshold.
- As the tax implications can significantly impact post-maturity returns, understanding the nuances of both old and ULIP new tax rules becomes crucial.
- While considering the taxation impact on ULIPs, investors must also account for ULIP Charges, which include allocation charges, fund management fees, and mortality charges.
** Tax exemptions are as per applicable tax laws from time to time.
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