Every year, taxpayers look for different ways to reduce their burden of taxation. There are many investment options that give you tax benefits. Unit Linked Insurance Policies are among the many tax-saving investments that investors can choose from. Aside from offering a life cover, a ULIP policy also gives the policyholder the opportunity to earn market-linked returns by choosing from ULIP funds like equity funds, debt funds, etc.
Therefore, with ULIPs, the nominee gets death benefits from the insurer in case of the policyholder’s death during the policy term. If the policyholder survives the policy term, at the end of the tenure, upon maturity of the ULIP, the insurer pays out the maturity benefits to the policyholder.
This brings us to the question of how the gains received on maturity are taxed. To understand how ULIP taxation works, let us first understand what long-term capital gains tax is.
What is long-term capital gains tax?
When an asset is sold, the seller earns some gains or profits from the sale. These profits are called capital gains, since they are derived from the sale of a capital asset. Depending on the tenure for which the seller held the said asset, these capital gains can be long-term or short-term.
Typically, if an asset is held for 36 months or longer before it is transferred, it is considered a capital asset. However, in the case of the following assets, they are classified as long-term assets if they are held for a period of 12 months or more –
• Equity or preference shares in a listed company
• Other listed securities
• Units of UTI
• Units of equity oriented funds
• Zero coupon bonds
The tax that is levied on the capital gains earned from the transfer of a long-term capital asset is called long-term capital gains tax. Since the lock-in period of ULIPs is 5 years, any returns earned from the investment in ULIP funds qualifies as long-term capital gains. So, is LTCG tax levied on these gains? Let us find out.
Does LTCG tax apply to ULIPs?
Budget 2021 has added high value ULIP’s in the definition of Capital Assets. High value ULIP plans are defined as ULIP policy with premium more than Rs.2.50 lakh and issued on or after February 1, 2021. Any gain derived from high value ULIP’s (other than death benefit) will be taxed as capital gain.
According to this amendment, in the case of any ULIPs purchased on or after February 1, 2021 with aggregate annual premium exceeding 2.5 lakhs, the LTCG earned on the maturity of the ULIPs are not fully tax-free. Amounts exceeding Rs. 1 lakh will be taxed at 10%1. However, ULIPs purchased before this cut-off date continue to remain tax-free if they fulfill the conditions as mentioned in Section 10(10D).
ULIP tax benefits
In addition to the benefits mentioned above, a ULIP policy also offers other tax advantages. Check out other aspects of ULIP taxation here –
1. Tax benefit on premiums
As per section 80C of the Income Tax Act, 1961, the premiums paid for ULIPs each financial year can be claimed as a deduction from the total income and this is allowed up to Rs. 1.5 lakh, subject to conditions stated therein. If policy is not satisfying the Section 10(10D) conditions, amount of deduction under Section 80C is restricted up to 10% of capital sum assured for policies issued on or after April 1, 2012 and for policies issued before April 1, 2012 amount of deduction is restricted up to 20% of capital sum assured.
2. Tax benefits on maturity (for ULIPs issued before February 1, 2021)
As per section 10(10D) of the Income Tax Act, 1961, benefits received from ULIPs are tax-free. This is applicable only if the annual premium is less than 10% of the capital sum assured for the policies purchased after April 1, 2012 (for the policies purchased before the said date, it is 20%).
3. Tax benefits on maturity (for ULIPs issued on or after February 1, 2021)
As per budget 2021, for ULIPs issued on or after February 1, 2021, if the premium exceeds Rs. 2.50 lakhs in any financial year during tenure of the policy, the proceeds from the policy shall be taxed at the time of maturity/surrender/withdrawal as the case may be. The exception to this would be any amount received by the nominee at the time of death of the policyholder. Note that the death proceeds will be taxable for keyman policy (Employer – Employee policy).
Therefore, that is how the benefits from ULIP funds are taxed. Remember to keep these pointers in mind when you begin tax planning for the year. That way, you can make an informed decision after factoring in all the tax benefits of a ULIP Policy.
1 This is applicable under the assumption that all ULIPs will be treated as equity oriented funds. However further clarity is awaited from the Govt.