Who can invest up to Rs 2.5 lakh in ULIP Life Insurance Policy to save money?

For a long time now, a ULIP or unit linked insurance plan has been recognized as a wise investment option. While buying life insurance plans, most people hope to find plans that their income tax calculator would approve. From the list of tax-saving financial instruments, ULIP or unit linked insurance plan has been a preferred one because ULIP investment gives you coverage like life insurance plans and creates an avenue for you to invest and build a corpus simultaneously. In addition to the attractive combination of insurance and wealth creation, ULIP is also a favoured option due to the viable tax benefits that India offers on them. An income tax calculator can quickly tell you just how much money a ULIP policy can save for you. However, Budget 2021 has raised many new questions about ULIP tax benefits.

Are ULIP policies a good investment option in 2021? How much can you invest in a unit linked insurance plan to receive tax benefits still? Should you add ULIP investments to your income tax calculator? Who can invest up to Rs.2.5 lakh in ULIP life insurance plans to save money and reduce tax liabilities?
Here's a quick recap of what ULIP policies can and cannot do for you after Budget 2021.

Here's a quick recap of what ULIP policies can and cannot do for you after Budget 2021.

What is a ULIP?

Offering a combination of life protection and savings, ULIP policies have been treated like a financial unicorn. When you invest, the goal is to make as much profit as possible while balancing your risk profile. Not everyone has the knowledge or money to invest in market-linked assets as they typically have a higher risk associated with it. With ULIP, you get a hybrid product that allows you to allocate your assets to investments in market-linked funds, making it perfect to meet your long-term financial goals.

Most ULIP products offer at least 3-9 fund alternatives. As a ULIP policyholder, you have the freedom to choose between these funds, redirect your money, and switch fund allocation when you please. Typical fund options include equity, debt, money market, or a balanced combination of these. With a fixed lock-in period of 5 years, most ULIP life insurance plans have a longer policy term of 15-20 years to maximize gains over a long-term investment horizon.
After the 5-year lock-in period, you can withdraw your ULIP funds by exiting the policy, or you can wait till the maturity of the policy to avail of additional bonuses. Upon exit for any reason, you stand to receive the fund value on that given day—this amount has enjoyed a tax-free status for years. This status is what has made ULIP life insurance plans a permanent fixture in anyone’s income tax planning, and a popular option as a tax-free return investment product. However, the new tax proposal presented in Budget 2021 seems to have upended a few of these presumptions about ULIP life insurance plans.

Before Budget 2021—ULIP Life Insurance Plans as a Tax-Free Investment

Within the Income Tax Act of 1961, many provisions are made to ensure that a taxpayer can invest and reduce their tax liabilities. Before Budget 2021, ULIP life insurance plans offered different tax exemptions under various sections of the IT Act.

As the product's name suggests, a unit linked insurance plan is at its heart an insurance plan. As with other life insurance plans, premiums paid towards ULIP are tax-deducted up to a sum of Rs. 1.5 lakhs in every financial year under Section 80C of the IT Act.

Under Section 10(10D) of the IT Act, ULIP policyholders are offered an utterly tax-free death benefit. Before Budget 2021, even the maturity benefits under a ULIP policy were tax-exempted. The only caveat for receiving tax-free maturity benefits from ULIP plans was that the annual premium paid on the ULIP had to remain under 10% of the sum assured listed in the policy.

These tax benefits are not offered in equity mutual funds or other market-linked financial products. For instance, those who invest in equity mutual funds have to pay long-term capital gains tax equal to 10% on any amount earned over Rs. 1 lakh. In contrast, ULIP policies had no such limitation. This is one of the main reasons why ULIP life insurance plans have been the chosen investment option for HNIs (high net-worth individuals) looking for a long-term wealth-builder with tax benefits.

Proposed Changes in Budget 2021

Amidst the COVID-19 pandemic, the Union Finance Minister Nirmala Sitharaman proposed Budget 2021-22 on the 1st of February, 2021. As per the proposal, there are no proposed changes in how Section 80C applies to ULIP life insurance plans. So, your ULIP policy remains a good bet and should make it to your income tax calculator and planning stage.

However, Budget 2021 did propose other amendments, the biggest of which was that the IT exemption available on maturity proceeds under Section 10(10D). As per the announcements made, a ULIP policyholder would receive tax exemptions on the maturity value of ULIP policies, but for only up to Rs. 2.5 lakh investment in a given financial year.

"In order to rationalise taxation of ULIP, it is proposed to allow tax exemption for maturity proceeds of the ULIP having annual premium up to Rs. 2.5 lakh. However, the amount received on death shall continue to remain exempt without any limit on the annual premium. 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. Further, in order to provide parity, the non-exempt ULIP shall be provided the same concessional capital gains taxation regime as available to the mutual fund," announced the Finance Minister.

These announcements led to a spate of questions about the viability of ULIP plans and the strategic choice of placing your hard-earned money in ULIP life insurance plans.

After Budget 2021—The Truth about Investing in ULIP Life Insurance Plans

On the 23rd of March, 2021, the Lok Sabha passed the Finance Bill with over 127 amendments. The original proposal stated that a ULIP policy with yearly premiums over Rs. 2.5 lakhs would no longer be eligible for tax-exemption on maturity and taxed like equity mutual funds. However, the final Finance Bill makes a few critical changes to the proposal.

According to the accepted amendment, there will now be minimum requirements of equity-holding on ULIP life insurance plans that feature premiums higher than Rs. 2.5 lakhs per annum. Factor this in while inputting ULIP premiums in your income tax calculator.

The amendment also suggests that for ULIP life insurance plans to be treated like equity mutual funds concerning capital gains tax, the ULIP has to meet this minimum equity holding yardstick. Further, the thresholds would need to be met through the course of the insurance policy.

As per the amended Finance Bill, for ULIP life insurance plans to be taxed on par with EMFs,

• If the ULIP is directly investing in stocks, the plan must have at least 65% of equity assets.
• If the ULIP is indirectly investing in stocks through vehicles like ETFs, the ULIP has to have at least 90% of its assets invested in equity.

If these caveats are not met, or your premiums fall below the Rs. 2.5 lakh investment threshold, you can continue factoring in ULIPs in your income tax calculator and enjoying tax-free maturity benefits.