Taxability of Unit-linked Insurance Plan (ULIP)

What is Unit Linked Insurance Plan

A Unit Linked Insurance Plan (ULIP) is an insurance plan that offers the dual benefit of investment to fulfil long-term goals, and a life cover` to financially protect family in case of an unfortunate event. The premium paid towards a ULIP is divided into two parts. A part of it is contributed to life cover`, and the remaining is invested in the fund of customer choice. Someone can choose to invest in equity, debt, or a combination of both funds as per risk appetite and goals. 

What is the Taxability of ULIP

Under the Income Tax Act, 1961, Individual can save tax on hard-earned money by investing in a ULIP. They can get tax advantage at different stages of their life insurance policy.

Stage 1: Entry Advantage  

Deduction under Section 80C is allowed for the investment made in ULIP. An Individual can claim a deduction for the investment made for himself, spouse, or children (dependent or independent) and HUF can claim a deduction for the investment made for any member of HUF.

Deduction under section 80C is restricted to 10% of the actual capital sum assured. It means that if the person pays an exorbitant premium for an insurance cover, the deduction shall not be allowed for the entire premium. The deduction will be limited to 10% of the sum assured, and any amount of premium paid more than this limit is not deductible under Section 80C.

Stage 2: Exclusive Switching Advantage  

In the ULIPs, the policyholders have an option to switch between different types of funds (equity, debt, money-market, or balance) or allocate money in a variety of funds. They can opt to switch the investment funds fully or partially into different portfolios according to their future needs and their risk appetite. 

No tax implications would arise on such switching from one fund to the other provided the maturity/redemption of units of ULIPs are exempt under Section 10(10D). If no such exemption is available for the excess premium or high-premium policies, such switching between the funds may be taxable under the head capital gains. However, the CBDT should provide clarity on this aspect.

Stage 3: Exit Advantage  

Section 10(10D) provides for exemption with respect to any sum received under ULIP, including the sum allocated by way of bonus on such policy. However, if the premium payable for any of the years during the term of the policy exceeds 10% of the actual capital sum assured, then no exemption under this section would be allowed with respect to the sum received under the policy. Such situation hereinafter referred to as ‘excess premium’. (Before the Budget)

(After the Budget) Besides restricting the exemption under Section 10(10D) for payment of excess premium, the Finance Bill, 2021 has proposed to insert Fourth and Fifth Proviso to Section 10(10D) that no exemption shall be available under this provision in respect of ULIPs issued on or after the 01-02-2021, if the amount of premium payable for any of the previous year during the term of the policy exceeds Rs. 2,50,000 (i.e., ‘high premium’ ULIPs).

The Fourth Proviso provides that no exemption shall be available for a policy, acquired on or after 01-02-2021, if the premium paid in any year during the tenure of the ULIP exceeds Rs. 2,50,000 (single policy). So, where premium payable for a policy exceeds Rs. 2.5 lakhs in any year during its tenure, no exemption under section 10(10D) will be allowed with respect to such policy.

The Fifth Proviso provides the exemption for all those policies whose aggregate premium in any year during the tenure of the policies is less than Rs. 2,50,000 (Multiple Policies). This would imply that in case the person has more than one policy acquired on or after 01-02-2021, and the premium payable for each of such policy during any year does not exceed Rs. 2.5 lakhs but the aggregate of premium payable for all such policies exceeds Rs. 2.5 lakhs in a year, the exemption under this section would be allowed only in respect of those policies whose aggregate premium is within such prescribed limit. Thus, in other words, exemption shall be allowed only with respect to low premium ULIPs the aggregate of which is under the threshold limit of Rs. 2.5 Lakh.

What are the rules regarding the maturity benefits of a ULIP?

Below are the rules regarding the taxation* of maturity benefits of a ULIP:

• If a ULIP or multiple ULIPs have been issued to you on or before February 1, 2021, then your maturity benefits for each of those ULIPs are tax-free* subject to conditions under Section 10(10D) of The Income Tax Act, 1961. This is irrespective of the total premiums you pay towards your policy/policies in any given year during the tenure of these policies
• If a ULIP has been issued to you on or after February 1, 2021 with annual premium less than ₹ 2.5 lakh for all the years during the tenure of the policy, then the maturity benefits from the ULIP is tax-free* subject to conditions under Section 10(10D) of The Income Tax Act, 1961
• If a ULIP has been issued to you on or after February 1, 2021 with premium more than ₹ 2.5 lakh in any given year during the tenure of the policy, then the maturity benefits from the ULIP is taxable. This is as per the fourth proviso of Section 10(10D)* of The Income Tax Act, 1961
• If multiple ULIPs have been issued to you on or after February 1, 2021, then the below rules apply as per Section 10(10D)* of The Income Tax Act, 1961:
• If the total annual premium for all these ULIPs issued on or after February 1, 2021 is less than ₹ 2.5 lakh for all the years during the tenure of all these policies, then the maturity benefits received from each of these ULIPs is tax-free* subject to conditions mentioned under Section 10(10D) of The Income Tax Act, 1961
• If the total premium for all these ULIPs issued on or after February 1, 2021 is more than ₹ 2.5 lakh in any given year during the tenure of the policy, then those policies whose combined total annual premium is less than ₹ 2.5 lakh will provide tax-free* maturity benefits subject to conditions mentioned under Section 10(10D) of The Income Tax Act, 1961. The maturity benefits of the remaining policies will be taxable.

Note : In the event of the death of the policy-holder, the exemption shall not be denied under Section 10(10D) from either of the policy, that is, excess premium policy (more than 10% of sum assured) or higher premium policy (more than Rs. 2,50,000).

Taxability under which head of Income

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.

If such ULIPs are equity-oriented and chargeable to STT, the tax shall be levied at the rate of 15% in case of short-term capital gain (section 111A) and at the rate of 10% in case of long-term capital gain (Section 112A).

In short, we can say that ULIP plans are now at par with stocks or mutual funds.

Example 1:

The assessee has the following policy which satisfies all the conditions laid down in clause (10D) of section 10 of the Act (other than the conditions provided under the fourth and fifth proviso of the said clause, applicability whereof is being explained in the example).

Taxability as per fourth proviso to clause (10D) of section 10 of the Act:

The sum received on maturity will be exempt under clause (10D) of section 10 of the Act as the policy has been issued before 01.02.2021 and accordingly not covered by the 4th to 7th provisos to the said clause (10) of section 10, inserted by Finance Act, 2021.

Example 2:

The assessee has the following policy which satisfies all the conditions laid down in clause (10D) of section 10 of the Act (other than the conditions provided under the fourth and fifth proviso of the said clause, applicability whereof is being explained in the example). The assesse did not receive any consideration under any other eligible ULIPs in earlier previous years preceding the previous year 2031-32.

Taxability as per fourth proviso to clause (10D) of section 10 of the Act:

The consideration received will not be exempt under clause (10D) as per the provisions of fourth proviso since the annual premium payable on the policy exceeded Rs 2,50,000.

Example 3:

The assessee has the following policies all of which satisfy all the conditions laid down in clause (10D) of section 10 of the Act (other than the conditions provided under the fourth and fifth proviso of the said clause, applicability whereof is being explained in the example). The assessee did not receive any consideration under any other eligible ULIPs in earlier previous years preceding the previous year 2031-32. (It needs to be specified that consideration under ULIP “X” has not been claimed exempt)

Taxability as per fifth proviso to clause (10D) of section 10 of the Act:

• The consideration under ULIP “X” was not claimed to be exempt under clause (10D) by the assessee therefore it is not covered within the definition of old ULIP.
• The consideration received under ULIPs “A” and “B” will be exempt under clause (10D). However, since aggregate of the annual premium payable for the ULIPs “A” and “B” together did not exceed Rs 2,50,000 for any of the previous years during the term of any of these ULIPs “A” or “B” and ULIP “X” was not claimed to be exempt under clause (10D)the consideration received under ULIP “C” will be taxable as per the provisions of fifth proviso to the said clause (10D) of section 10 of the Act.

Example 4:

The assessee has the following policies all of which satisfy all the conditions laid down in clause (10D) of section 10 of the Act (other than the conditions provided under the fourth and fifth proviso of the said clause, applicability whereof is being explained in the example). The assessee did not receive any consideration under any other eligible ULIPs in earlier previous years preceding the previous year 2032-33 other than under ULIPs “X” and “Y”.

Taxability as per fifth proviso to clause (10D) of section 10 of the Act:

• The surrender value of ULIP “X” and consideration received under ULIP “Y” on maturity will be exempt under clause (10D) since the annual premium does not exceed Rs 2,50,000 during the term of these policies.
• The consideration received under ULIPs “A”, “B” and “C” will be taxable under clause (10D) as per the provisions of fifth proviso to the said clause (10D) since
  aggregate of the annual premium payable for the ULIPs “X” and “Y” for the previous years 2021-22 to 2025-26 was Rs 2,00,000. If the annual premium of ULIP “A” or “B” or “C” is added then the aggregate of the premium will exceed Rs 2,50,000 for the previous years 2022-23 to 2025-26.
• As per the provisions of fifth proviso, in case of multiple ULIPs, the aggregate of the premium payable for all the policies which are claimed to be exempt under clause (10D) shall not exceed Rs 2,50,000 for any previous year during the term of any of the policies.