The tax exemption on Ulips maturity product with an aggregate annual premium of more than Rs 2.5 lakh has been removed. However, there will be no tax on the proceeds in the event of the death of the policyholder
With rising stock markets, increased financial savings and higher risk appetite among young investors, life insurance companies’ unit-linked (Ulips) insurance plans have seen a strong growth during the current financial year. In new individual regular business, sales of Ulips grew by 49% year-on-year to Rs 13,000 crore in the first nine months of this financial year. In the new sole proprietorship, Ulip’s sales rose 85% year-on-year to Rs 4,330 crore in the same period, according to data from the Insurance Regulatory and Development Authority of India.
The rebound in Ulip sales despite the 2021-22 Union budget eliminating the tax arbitrage between Ulips and mutual fund investments for high-value investors, indicates that individuals are ready to invest in a life insurance for investments because they are profitable, secure and the risk of mis-selling is lower. Experts believe Ulips sales will pick up steam during the tax-saving season through March.
Should you invest in Ulips or ELSS?
Ulips are tied to the market with a thin crust of life insurance. These products have a lock-up period of five years compared to three years for mutual fund equity savings plans (ELSS). Additionally, in a Ulip, an investor is locked in with the same funds and fund managers for the duration of the plan. The amount invested in Ulips is eligible for tax deduction under Section 80C subject to a maximum of Rs 1.5 lakh per annum, but on the condition that the premium does not exceed 10% of the sum insured. Investors can choose the mix of funds – large, mid or small cap equity or even debt funds to invest in depending on their risk appetite.
Policyholders can switch from one fund option to another by paying a transfer fee to the insurance company. However, in ELSS, investments cannot be touched until the lock period ends.
Although the insurance regulator has capped the exorbitant upfront charges taken by insurers in Ulips, the charges are still higher than equity-linked investments, where the expense ratio is 1-2.5%. Insurers charge four types of fees in Ulips: allocation, policy administration, mortality and fund management fees. Insurers deduct premium allocation fees to recover costs incurred in processing the policy such as underwriting, medical examinations and distribution fees directly from the premium. Thus, higher fees in Ulips reduce overall long-term returns.
No tax arbitration in Ulips
Last week, the Central Board of Direct Taxes notified new standards for the calculation of capital gains under Ulips. The government had removed the tax exemption on the maturity product of Ulips with an aggregate annual premium of over Rs 2.5 lakh. Tax exemption is now only available for investment up to Rs 2.5 lakh under Section 10(10)D of the Income Tax Act. Long Term Capital Gains Tax (LTCG) will apply to Ulips like all equity-based investments. However, there will be no tax on the proceeds in the event of the policyholder’s death. In order to maintain the real intent of the clause which benefited small and genuine cases, the proceeds received on the death of the individual by his nominee will be exempt from tax.
Long-term capital gains (holding period of more than 12 months) exceeding Rs 1 lakh in a financial year are taxed at 10% and short-term capital gains tax of 15% is levied on overall earnings (holding period less than 12 months). For tax-planning equity investments, experts suggest investors should have a balanced portfolio of Ulips and ELSS for long-term returns.
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