Unit linked insurance plans

Unit linked insurance plans: Check tax norms for capital gains on ULIPs

Stock markets are inherently volatile, and the present global situation has seen a lot of volatility in the stock markets across the world. Young investors have a higher risk appetite and that makes Unit Linked Insurance Plans or ULIPs an attractive avenue.

From the data reported in the Financial Express, the sales of ULIPs during the first nine-months of 2021-2022 have increased on a 49% year-on-year basis for individual regular new business, whereas it has grown at 85% year-on-year for individual single premium new businesses. This increase in sales numbers is despite the Union Budget of 2021-22 eliminating any tax arbitrage opportunity between ULIPs and equity mutual fund investments for high-value investors. It also indicates that people are willing to purchase ULIPs for being cost-effective, secure and for a lower chance of mis-selling.

What are ULIPs?

ULIPs are insurance-cum-investment plans that offer insurance and investment in the same policy. When a policyholder purchases a ULIP, a part of its premium is allocated towards providing life insurance coverage for unfortunate events like death or disability. However, the balance premium is apportioned to making investments that are linked to markets. These investments are either made in equity or debt funds that fluctuate with the demand and supply in the open markets. To summarise, ULIPs are insurance-cum-investment plans that help to ensure a financial safeguard for your family and meet your financial goals.

Tax rules for the calculation of capital gains on ULIPs

The Central Board of Direct Taxes (CBDT) announced that all income received from ULIPs issued after 01st February 2021 with annual premiums of more than ₹2.5 lakhs (i.e. high-value premium policies) will be taxed as per applicable tax laws. Thus, all ULIPs that have an annual aggregate premium below ₹2.5 lakhs are exempt from any capital gains. This exemption is available under Section 10(10D) of the Income Tax Act. However, those ULIPs that are purchased before the cut-off date of 01st February 2021 will continue to remain tax-free if they satisfy all conditions that are laid down in the Section 10(10D).

For the purpose of computing tax, long term capital gains (LTCG) shall be applicable, similar to equity-oriented investment. However, in the event of the death of the policyholder, no tax shall be levied on the proceeds in that case. To ensure that the insurance part of the ULIP retains its flavour, these proceeds received by the nominee, in the event of an unfortunate demise, are made tax-free.

The framework to compute these capital gains considers all payments that are received by the policyholder as income of such policyholder. This includes the bonuses received during the period. From such income, any premiums paid till the date of withdrawal must be deducted to arrive at the capital gain amount on which tax shall be computed.

In case, there are multiple payments during the tenure, the previous amounts that are considered for premium payments shall not be accounted for calculating the capital gains at a subsequent time. To simplify, only the fresh income received and fresh premiums paid, are considered to determine the capital gains on which the tax shall be computed.

The holding period of the investment is looked at to determine the type of capital gains tax. Long-term capital gains (holding period is more than 12 months) above ₹1 lakh in a financial period are taxed at the rate of 10%, whereas short term capital gains (holding period is less than 12 months) are taxed at 15%.

Other than the above tax implications on ULIPs, the other aspects of its taxation are as follows –

  • Tax benefit on premium

The premiums that are paid towards buying a ULIP are deductible under Section 80C of the Income Tax Act. Thus, eligible policyholders can claim a deduction upto ₹1.5 lakhs in their return of income.

  • Tax benefit at maturity for policies issued before 01st February 2021

Section 10(10D) provides an exemption for the benefits received from ULIPs in case its annual premium is less than 10% of its capital sum assured for all those policies purchased after 01st April 2012. For plans that are purchased before the said date of 01st April 2012, exemption under Section 10(10D) is available if the premium is up to 20% of its capital sum assured.


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