Exploring the Taxation for ULIPs Purchased After February 2021 and Other Tax Rules

As they are a type of life insurance policy, ULIPs (Unit Linked Insurance Plans) have traditionally been eligible for tax deductions under Section 80C, and the maturity proceeds/death benefits are exempted from taxation under Section 10D (10D) of the Income Tax Act. In recent times though, the Government has revised the tax rules for ULIP plans, and the Central Board of Direct Taxes has published a notice regarding certain changes. According to the notification, the proceeds from ULIPs will lose their tax-exempt status if the total premiums for all ULIP policies held by an individual (single or multiple) surpass Rs. 2.5 lakh annually.

These changes have been made to bring ULIPs in line with other investment options, such as Equity-Linked Saving Schemes (ELSS) and National Pension System (NPS. But first, there is a need to understand what is a ULIP before getting into these changes. This is because a solid understanding of the product is necessary before gaining more knowledge about taxation rules.

What is ULIP Plan?

A Unit-Linked Insurance Plan (ULIP) is a type of insurance product that combines the features of both insurance and investment. It is a long-term investment plan that offers a combination of life insurance coverage and investment in market-linked assets.

ULIPs typically have a lock-in period of five years, during which the policyholder cannot withdraw the investment. The policyholder pays the premium to purchase units in the underlying investment fund, which can be equity, debt, a mix of both, or liquid funds. The value of the units is determined by the market value of the particular assets and can increase or decrease depending on the investment fund’s performance.

One of the main advantages of a ULIP plan is its flexibility. Policyholders can choose the type of investment fund they want to invest in and change the fund allocation during the policy term. This allows policyholders to align their investment strategy with their risk appetite and financial goals.

Another advantage of ULIPs is that they offer life insurance coverage. This means that in case of the policyholder’s death, financial security for the family is assured.

Finally, as mentioned at the beginning of the article, ULIPs also offer tax benefits. Premiums paid for ULIPs qualify for tax deductions specified under Section 80C of the Income Tax Act up to Rs. 1,50,000. The death benefit is also tax-free under Section 10D. Coming to the maturity proceeds earned from ULIPs, the new tax rules require careful examination since the annual premium payment now plays a crucial role in determining whether any taxes will be levied.

What are the tax rule changes?

As per changes introduced in the budget for FY 2021, the tax-exempt status of ULIP earnings will be removed if the annual premium exceeds Rs 2.5 lakh.

Maturity proceeds from Old ULIPs purchased before February 1, 2021, are entirely exempt; however, this does not imply that purchasing a new ULIP with premiums up to Rs 2.5 lakh will grant tax-free status to investors. According to the CBDT announcement published on January 19, 2022, the Income Tax Department will consider both the new and the old ULIPs. If the total premium exceeds Rs 2.5 lakh, the new ULIP will not qualify for the exemption.

Fourth through seventh provisos were added to Section 10 (10D) of the Finance Act of 2021. The fourth proviso states that, as of 01.02.2021, the amount received under a ULIP issued on or after February 2021 shall not be exempt under the aforementioned clause (Section 10D) if the amount of premium payable for any prior year during the term of the such policy exceeds Rs 2,50,000.

The fifth proviso further stipulates that the exemption under the said clause will only be available with respect to such policies where the total premium for more than one ULIP issued on or after 01.02.2021 does not exceed Rs 2.5 lakhs for any of the previous years during the policy term. Finally, the sixth proviso states that if money is received upon someone’s death, the fourth and fifth provisos do not apply.

Note that the maturity proceeds will be taxed as Long Term Capital Gains (LTCG), and the rules of LTCG taxation will apply.

In conclusion, new ULIPs purchased after February 2021 should be purchased carefully by investors, determining whether they retain their tax-exempt status. This is where the annual premium payable should be evaluated, and the investment strategy tweaked in consultation with a financial advisor to maximize available tax benefits. ULIPs are regarded as a highly effective investment option for creating future wealth. However, checking all applicable tax rules carefully before investing is essential.

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