What are the taxes applicable on ULIP gains?

Picture this: you’re planning for your future, looking for a smart investment that not only grows over time but also offers you peace of mind with life cover. You come across ULIPs, a unique financial vehicle that promises the best of both worlds – investment and insurance. As you dive deeper, you realise that while ULIPs seem like a perfect savings plan for your long-term goals, there’s a crucial aspect you need to understand better – the tax implications on the gains you earn from these investments.

ULIPs have garnered attention for their dual benefits. However, the tax rules governing the returns on ULIPs can be complex and have undergone several changes over the years. This blog aims to shed light on the taxes applicable to ULIP gains, breaking down the legal jargon into simple, actionable insights, making this guide an indispensable resource for Indian investors.

Taxation on ULIP gains

The taxation rules for ULIPs are aligned with the aim of encouraging long-term savings while ensuring that high-value investments are taxed appropriately. Here are the key points concerning ULIP taxation:

1. Tax Exemption on Maturity Proceeds: Under Section 10(10D) of the Income Tax Act, the maturity proceeds from ULIPs are exempt from tax, provided the premium paid does not exceed 10% of the sum assured for policies issued after April 1, 2012. For policies issued before this date, the premium should not exceed 20% of the sum assured.
2. Taxation of High Premium ULIPs: In the 2021 budget, the government introduced a new provision to tax ULIPs where the annual premium exceeds ₹2.5 lakh. If an individual holds multiple ULIPs with premiums exceeding this limit in aggregate, the gains from these policies are taxable as capital gains. This move was aimed at bringing high-value ULIP investments on par with mutual funds for tax purposes.
3. Long-term Capital Gains Tax (LTCG): For ULIPs falling under the taxable category (premiums above ₹2.5 lakh), the gains are subject to Long-term Capital Gains Tax at the rate of 10% without indexation benefit, if the total gains exceed ₹1 lakh in a financial year. This is similar to the taxation on equity-oriented mutual funds.

Let’s consider two scenarios to understand how the taxation on ULIP gains works:

Scenario 1: Mr. A invests in a ULIP with an annual premium of ₹2 lakh for a policy term of 20 years. The sum assured is ₹20 lakh. Since the premium does not exceed 10% of the sum assured, the maturity proceeds from this ULIP will be tax-exempt under Section 10(10D).

Scenario 2: Mrs. B invests in multiple ULIPs with a combined annual premium of ₹3 lakh. The sum assured in her case is ₹25 lakh. Since the total premium exceeds the ₹2.5 lakh limit, the gains from these policies will be taxable. If the long-term gains exceed ₹1 lakh at the time of redemption, they will be taxed at 10% under the LTCG tax.

Planning your ULIP investments wisely

When it comes to ULIP investments, strategic planning is paramount to maximise benefits while minimising tax liabilities.

Start by aligning your ULIP choices with your financial goals, whether it’s retirement, education funding, or major purchases. Each goal dictates the policy term, premium amount, and investment risk level.

Selecting the right savings plan, such as ULIP, involves comparing fund options, charges, and performance histories, with an eye on equity-heavy funds for higher risk tolerance and debt-focused or balanced funds for conservative investors. Be mindful of the annual premium cap of ₹2.5 lakh to maintain tax-exempt status on maturity proceeds under Section 10(10D).

Regular portfolio monitoring and rebalancing in response to market shifts or changes in risk appetite are crucial. Utilise the flexibility of ULIPs to switch between funds, but watch out for any associated charges.

Adopt a long-term perspective to benefit from market compounding and tax exemptions, keeping investments aligned with the lock-in period. A ULIP calculator can be instrumental in estimating potential returns and understanding the impact of different investment strategies on outcomes.

Finally, staying updated on tax laws affecting ULIPs ensures your investment strategy remains effective and aligned with current regulations. Thoughtful planning and a strategic approach to ULIP investments can help build a substantial corpus for future financial needs, making ULIPs a valuable part of your investment portfolio.

Conclusion

ULIPs can be a powerful component of your financial portfolio, offering the benefits of a savings plan with the added advantage of life cover. Understanding the tax implications on the gains from ULIPs is crucial for effective financial planning.

By making informed decisions and using tools like a ULIP calculator, investors can maximise their returns while optimising tax savings, ensuring that their long-term financial goals are met in a tax-efficient manner.

Moreover, keeping abreast of the ever-changing tax regulations will ensure your investment decisions remain both prudent and beneficial in the long run. ULIPs, with their unique combination of investment and insurance benefits, can indeed serve as a cornerstone for building a robust financial future when approached with thoughtful consideration and strategic acumen.