Taxation of Unit Linked Insurance Plans (ULIPs): A Comprehensive Guide

Introduction to ULIPs

Unit Linked Insurance Plans (ULIPs) are a unique financial product that offers the dual benefits of life insurance and investment. A portion of the premium paid for a ULIP is invested in a variety of market-linked funds, while the remaining portion is used to provide life insurance coverage. ULIPs offer investors an opportunity to invest towards a life insurance policy and mutual fund with a single plan.

Key Features of ULIPs

ULIPs are versatile, offering a range of features that make them a sound investment choice:

1. Investment Choices: ULIPs offer a variety of fund options. Whether you’re a risk-taker aiming for high returns in the stock market or someone who prefers stable income sources like bonds, there’s a fund for you.

2. Life Cover: The life insurance cover ensures that your loved ones are financially secure in the unfortunate event of your death.

3. Flexibility: You can switch between funds, make partial withdrawals, and choose your premium amounts. This adaptability makes ULIPs suitable for varying financial goals and market conditions.

Taxation of ULIPs

Section 10(10D)-

(10D) any sum received under a life insurance policy, including the sum allocated by way of bonus on such policy, other than—

(a) any sum received under sub-section (3) of section 80DD or sub-section (3) of section 80DDA; or

(b) any sum received under a Keyman insurance policy; or

(c) any sum received under an insurance policy issued on or after the 1st day of April, 2003 but on or before the 31st day of March, 2012 in respect of which the premium payable for any of the years during the term of the policy exceeds twenty per cent of the actual capital sum assured ; or

(d) any sum received under an insurance policy issued on or after the 1st day of April, 2012 in respect of which the premium payable for any of the years during the term of the policy exceeds ten per cent of the actual capital sum assured:

Provided that the provisions of sub-clauses (c) and (d) shall not apply to any sum received on the death of a person:
Provided further that for the purpose of calculating the actual capital sum assured under sub-clause (c), effect shall be given to the Explanation to sub-section (3) of section 80C:

Provided also that where the policy, issued on or after the 1st day of April, 2013, is for insurance on life of any person, who is—

(i) a person with disability or a person with severe disability as referred to in section 80U; or

(ii) suffering from disease or ailment as specified in the rules made under section 80DDB,

the provisions of this sub-clause shall have effect as if for the words "ten per cent", the words "fifteen per cent" had been substituted:

[Provided also that nothing contained in this clause shall apply with respect to any unit linked insurance policy, issued on or after the 1st day of February, 2021, if the amount of premium payable for any of the previous year during the term of such policy exceeds two lakh and fifty thousand rupees:

Provided also that if the premium is payable, by a person, for more than one unit linked insurance policies, issued on or after the 1st day of February, 2021, the provisions of this clause shall apply only with respect to those unit linked insurance policies, where the aggregate amount of premium does not exceed the amount referred to in fourth proviso in any of the previous year during the term of any of those policies:

Provided also that the provisions of the fourth and fifth provisos shall not apply to any sum received on the death of a person:

Following provisos shall be substituted for the existing sixth proviso to clause (10D) of section 10 by the Finance Act, 2023, w.e.f. 1-4-2024:

Provided also that nothing contained in this clause shall apply with respect to any life insurance policy, other than a unit linked insurance policy, issued on or after the 1st day of April, 2023, if the amount of premium payable for any of the previous years during the term of such policy exceeds five lakh rupees:

Provided also that if the premium is payable by a person for more than one life insurance policy, other than unit linked insurance policy, issued on or after the 1st day of April, 2023, the provisions of this clause shall apply only with respect to those life insurance policies, other than unit linked insurance policies, where the aggregate amount of premium does not exceed the amount referred to in the sixth proviso in any of the previous years during the term of any of those policies:

Provided also that the provisions of the fourth, fifth, sixth and seventh provisos shall not apply to any sum received on the death of a person:

Provided also that if any difficulty arises in giving effect to the provisions of this clause, the Board may, with the previous approval of the Central Government, issue guidelines for the purpose of removing the difficulty and every guideline issued by the Board under this proviso shall be laid before each House of Parliament, and shall be binding on the income-tax authorities and the assessee.]

Explanation 1.—For the purposes of this clause, "Keyman insurance policy" means a life insurance policy taken by a person on the life of another person who is or was the employee of the first-mentioned person or is or was connected in any manner whatsoever with the business of the first-mentioned person and includes such policy which has been assigned to a person, at any time during the term of the policy, with or without any consideration.

Explanation 2.—For the purposes of sub-clause (d), the expression "actual capital sum assured" shall have the meaning assigned to it in the Explanation to sub-section (3A) of section 80C.

[Explanation 3.— For the purposes of this clause, "unit linked insurance policy" means a life insurance policy which has components of both investment and insurance and is linked to a unit as defined in clause (ee) of regulation 3 of the Insurance Regulatory and Development Authority of India (Unit Linked Insurance Products) Regulations, 2019 issued by the Insurance Regulatory and Development Authority under the Insurance Act, 1938 (4 of 1938) and the Insurance Regulatory and Development Authority Act, 1999 (41 of 1999);]

ANALYSIS

Understanding the taxation rules for ULIPs is crucial for maximizing returns. The premiums paid are eligible for tax deductions under Section 80C of the Income Tax Act. This can reduce your taxable income by up to Rs 1.5 lakh per year. However, to avail these benefits, the premium amounts should not exceed 10% of the sum assured.

Before February 1, 2021, whatever returns you received on the maturity of a ULIP plan were tax-free under Section 10 (10D) of the ITA. However, the Finance Act, 2021, introduced certain provisions through amendments to Section 10 (10D) and the applicability is from February 1, 2021. As per this, certain ULIP plans will no longer have exemptions, in case:

1. The policies are issued on or after February 1, 2021, and

2. In case you have paid an insurance premium of Rs 2.5 lakh or more for any of the previous years, then the amount received (including the bonus) at the time of maturity will be taxable.

Long-term capital gains (LTCG) tax will be applicable on ULIPs like the tax on all equity-oriented investments. Also, tax shall be paid (in the case of long-term capital gains (LTCG) at 10%. However, no taxation is imposed in the case of a death of an individual.

IMPORTANT CRUX-

- If ULIP is issued on or after 01-02-2021 then if the amount of premium exceeds two lakh fifty thousand rupees in any year during the term of policy.

- If more than one ULIP’s issued on or after 01-02-2021 then those ULIP’s are exempt whose premium amount does not exceed two lakh fifty thousand rupees in aggregate in any of the year during the tenure of policy.

- If maturity amount of ULIP is received on death of a person then it is not taxable irrespective of amount of premium paid.

Government’s Stand on ULIPs Taxation Policy

The tax exemption which ULIPs have been getting so far was taken away in Budget 2021, which made any gain from ULIPs, where annual premium above Rs 2.5 lakh, taxable. This move was aimed at ensuring that high net-worth individuals could not claim large exemptions by investing in ULIPs with a high premium. The government’s intention was to bring ULIPs at par with other equity-oriented investments in terms of taxation.

Conclusion

ULIPs are a unique financial product that combines the benefits of life insurance and investment. While they offer several advantages, it’s important to understand the taxation rules associated with them. The recent changes in the taxation policy of ULIPs have made it even more crucial for investors to be aware of these rules. As always, it’s advisable to consult with a financial advisor or tax consultant to understand how these rules apply to your specific situation.