Budget Impact: ULIPs with over Rs.2.5 lakh annual premium to lose their tax-edge over equity MFs

There has been an amendment in the Income Tax Act, proposed by FM Nirmala Sitharaman. According to which the maturity proceeds of ULIPs, taken on or after Feb.1 with an annual premium of more than Rs.2.5 lakh will be taxable on par with equity linked mutual fund schemes. The government is trying to ensure that all investments should be treated in a similar manner.  Reinforcing the fact that we need to consider insurance primarily for protection and then as an investment option.

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The amendments shall be effective from 1st April,2021 and applicable to the assessment year 2021-2022 and subsequent assessment years thereafter. 

Until now ULIPs gained importance after the introduction of capital gains tax on investments in equity and equity linked instruments in Budget 2018. Long term capital gains tax of 10% was levied on the returns of such investments held for more than one year.

Before this proposed change, the proceeds from unit linked insurance plans had large investors getting tax free returns. As per clause (10D) of section 10 of the Income Tax Act, any return on unit-linked insurance plans after 5 years of initial lock-in is exempt for tax. Existing provisions exempt any amount received under a life insurance policy including ULIPs to go tax free, if the sum assured is more than 10 times the annual premium. Hence the sum received under a life insurance policy and the sum allocated by way of bonus on such policy in respect of which the premium payable for any of the years during the terms of the policy does not exceed 10% of the actual sum assured is exempt.

The aim was to benefit the small and genuine cases of life insurance.  But it has been observed that high net worth individuals claim exemption under the aforementioned clause by investing in ULIP with a huge premium which defeats the legislative intention itself. Such ULIPs will be taxed @ 10% closing exemption available only to wealthy individuals.  This might as well result into a dent in ULIP sales going ahead.

Budget 2021 has made the gains from the above ULIPs capital gain just like equity MFs and will be taxed accordingly. This will make these high value investments less attractive for the taxpayers as they are now required to pay capital gains tax on maturity.

In addition to the above, if multiple ULIPs are brought with smaller amounts of premium, that will not help in saving taxes as the proposed amendment will take the aggregate amount of all ULIPs held by the taxpayer.  The exemption on premium payable by the taxpayer for more than one ULIP, issued on or after 1st February 2021 shall be available only with respect to such policies aggregate premium whereof does not exceed Rs.2.5 lakh for any of the previous years during the term of any of the policy. This further infers that the budget taxes returns from such ULIPs at 10% above an annual exemption of Rs. 1 lakh, on par with equity mutual funds.

The redemptions which have been exempted after 5 years of lock-in under ULIPs will be included in the definition of equity oriented fund in section 111A and 112A.  Sale or redemption of such ULIPs will attract provisions of sections 111A and 112A. 

ULIPs chain both life insurance and investments into equity and debt. If the policy holder dies, either the sum assured or the proceeds of the investments, whichever is higher, are paid to the nominee. This amount continues to remain tax free. The new provision applies to only ULIPs. Endowment plans and money back policies still provide the maturity benefit keeping the tax exemptions intact. 

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Krishna Rath is a SEBI Registered Investment Adviser, and since 2015 has been educating netizens on investments and insurance. Krishna is a fee only SEBI RIA and is Odisha's first SEBI RIA. With background in IT, Krishna is changing the advisory space with new innovations in AdvisoryTech.

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