Life insurance plans are a great tax saving tool. Besides providing financial security against the risk of premature death, life insurance plans allow you to save tax on the premium that you pay as well as earn tax-free benefits. Unit linked insurance plans provide investors with a good mix of investment returns, insurance coverage and tax-saving benefits. However, in the latest Union Budget 2021, the Finance Minister, Mrs. Nirmala Sitharaman, made ULIPs taxable in certain cases. Do you know the latest tax implication on ULIPs?
Before we jump to the new changes, let’s brush up on the existing tax benefits that ULIPs provided policyholders –
Tax benefit under Section 80C
Premiums paid towards ULIPs, except pension ULIPs, are allowed as a tax-free deduction under Section 80C of the Income Tax Act, 1961. The maximum deduction available under this Section is INR 1.5 lakhs.
Tax benefit under Section 80CCC
Premiums paid towards a deferred pension ULIP plan are allowed as a deduction under this Section. The limit is INR 1.5 lakhs that includes the limit under Section 80C as well.
Tax benefit under Section 10(10A)
On maturity of a deferred pension ULIP plan, you can withdraw up to 60% of the accumulated corpus in lump sum. Technically, this withdrawal is called the commutation of pension. Up to 33% of the withdrawn corpus is allowed as a tax-free benefit under this Section.
Tax benefit under Section 10(10D)
This section is relevant for maturity proceeds received from the ULIP plan. If the premium that you paid for the policy did not exceed 10% of the sum assured (20% for policies issued on or before 31st March 2012), the maturity proceeds would be tax-free.
Besides these benefits, partial withdrawals, premium redirections and switching are also tax-free under ULIPs.
What has changed?
A new provision has been introduced in the Union Budget 2021 regarding the taxation of ULIPs. As per the new rule, if the aggregate premium exceeds INR 2.5 lakhs, ULIPs would attract long term equity taxation. That means, if the returns earned from ULIPs exceed INR 1 lakh, the excess returns would be taxed @10% under Section 112A of the Income Tax Act, 1961. If the ULIP is held for less than 12 months, the returns earned would be considered a short-term capital gain and would be taxed @15%. That being said, since ULIPs have a lock-in period of five years, short term capital gains would become irrelevant.
Here are some important rules to remember with respect to the latest tax implication on ULIPs –
- The new tax rule would be applicable on new plans that you buy on or after 1st February 2021. For existing unit linked plans, the rule would not be applicable and you can enjoy full tax benefits
- If you invest in multiple unit linked plans, the aggregate premium of all the plans would be considered against the threshold limit of INR 2.5 lakhs
- The death benefit would always be tax-free irrespective of the premium amount
- The new tax rule would be applicable only on the maturity benefit
- The tax benefit on premium would be allowed under Section 80C and 80CCC
So, the next time you are investing in ULIPs and you are paying a high premium, remember the new tax rules to assess your tax liability on maturity. Also, remember that your premiums would still be allowed as a deduction and so, you can invest in ULIPs for saving taxes on the amount you invest. Invest in ULIPs, despite the tax implication, because you can earn investment returns while at the same time enjoying insurance coverage, a benefit that is not available under other investment avenues.
