A Unit Linked Insurance Plan (ULIP) is considered one of the most popular choices for customers today. It combines both investment and insurance. The only differences between ULIP insurance and a mutual fund are that you also obtain life insurance and that they don’t “directly” invest in the stock market but rather do so through market-linked funds. As a result, they have been gaining popularity in recent years due to their flexibility and the ability to provide life cover and investment growth. ULIPs become especially popular towards the end of the year before tax filing commences, as they are regarded as some of the best options for saving taxes. 

In recent years, there have been significant changes in the rules for ULIP taxation. In this article, let’s see what tax benefits are provided by ULIPs under different sections Income Tax Act of 1961 and how the new tax rules may impact the various aspects of ULIP tax benefits.

What are the new taxation rules for ULIPs?

ULIPs have been some of the most tax-efficient investment plans in India. When you consider the investment options available within a ULIP, this is an unbeatable market investment option. One can work out their estimated returns by using a ULIP calculator.

Tax benefits on your investments and maturity returns meant that you could build wealth almost without any taxation. However, with the new tax regime, even ULIPs have come under the taxman’s ambit.

Here are the new tax rules for ULIP, which came into effect starting February 2021.

ULIP returns can now be taxed

Previously, ULIP returns were not taxed, provided your annual investment (premiums) did not exceed 10% of the plan’s life insurance. However, the returns you receive will be taxed if you pay more than Rs 2.5 lakh in ULIP premiums. The tax rate will be determined by the composition of your ULIP funds.

The restriction of Rs 2.5 lakhs applies to the total premium of all plans purchased on or after February 1, 2021. As a result, if you began two ULIP investments after February 1 and the total yearly premium exceeds ₹2.5 lacs, both ULIPs will become taxable.

Fund Switching will have an impact on taxation

Fund swaps are available in the majority of ULIPs. This allows you to switch funds if you believe you can receive a greater return. These ‘switches’ were almost always free. However, this may no longer be the case. This is because ULIPs are now taxable.

2(a). The tax will be calculated based on the length of time you have owned the ULIP for

(i) Less than three years: Taxable at the tax slab rate 

(ii) More than three years: Chargeable at a rate of 20%.

2(b). The type of funds kept at maturity will be taxed under Section 112 and Section 112A.

Taxation of Death Benefits

The tax rules for the death benefit that your nominee will receive after your death remain unchanged. The death benefit is still tax-free under section 10(10D) of the Income Tax Act.

Do the new rules impact deductions under Section 80C for ULIPs?

Section 80C of India’s Income Tax Act allows an individual to claim a tax deduction of up to Rs. 1.5 lakhs annually on certain specified investments or expenses. Some of the common investments and expenses that are entitled to a tax deduction as per the rules of Section 80C include the Public Provident Fund (PPF), National Savings Certificate (NSC), Equity-linked Savings Scheme (ELSS), and Life Insurance Premium.

The amendments and new rule changes have not impacted Section 80C deductions. You can still get deductions up to Rs. 1,50,000 on the premium paid annually. However, you should note that this deduction is applicable if your premium is less than 10% of the sum assured, in case the ULIP has been bought after April 1, 2012. The policy should be in force for at least five years as well. For example, if the premium is Rs. 50,000 annually for a ULIP and the sum assured stands at Rs. 5 lakh, then the premium is at 10% of the sum assured. You can then claim a tax deduction of Rs. 50,000 under Section 80C if the policy has been active for more than five years. 

Furthermore, it is essential to note that ULIPs are subject to a lock-in period of 5 years. This means that the investor can only withdraw the investment after the completion of 5 years. Even if one chooses to surrender the policy before this lock-in period, they will get the amount after it ends, after deducting all applicable surrender charges.

Conclusion

In summary, ULIPs are eligible for tax deductions under Section 80C, provided certain conditions are met. You should also note other accompanying taxation rules before you finalize your investment. If required, take professional advice to ensure the best selection of the portfolio.

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