Tax on ULIP: Taxation Rules of Unit-Linked Insurance Plan

In an effort to make insurance policies a bit more lucrative in terms of rate of return, the concept of Unit-Linked Insurance Policy (ULIP) was introduced. In this, the amount of premium invested was diverted part towards life insurance, while a major portion was towards investment in the stock market directly or indirectly.

For example, consider you had invested in an insurance policy with a maturity period of 10 years, after which you will receive a fixed amount. 

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. Also, you could claim a tax deduction under Section 80C.

Amendment: Finance Tax, 2021 

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: 

• The policies are issued on or after February 1, 2021, and 
  • 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, or
  • In case an individual has purchased multiple ULIP plans and the aggregate amount paid is more than Rs 2.5 lakh, then it comes under the ambit of taxation

Tax on ULIP

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. 

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

However, let’s see some practical examples to know how the taxation rules will apply.

Examples

Example-1:

Mr, A and Mr B purchased ULIP plans with values of Rs 15 lakh and Rs 30 lakh, respectively, with a maturity period of 10 years. The annual premium paid by Mr A is Rs 85,000, while for Mr B, it is Rs 2.6 lakh.

After 10 years, the maturity proceeds that Mr A receives is Rs 20 lakh, while Mr B gets Rs 48 lakh. 

Now, the annual premium for Mr B exceeds Rs 2.5 lakh during the term of these policies. Since Mr B was making an annual contribution of an amount exceeding Rs 2.5 lakh, he is liable to pay tax on Rs 18 lakh (i.e. Rs 48 lakh – Rs 30 lakh), while Mr A will receive an exemption under Section 10(10D) as the annual premium was Rs 85,000 during the tenure of the policy.  (assuming that there was no combined contribution exceeding Rs 2.5 lakh on or after February 1, 2021).

Example-2:

An individual has a ULIP policy with the details mentioned below.

Taxability as per fourth proviso to Section 10(10D) of the ITA:  

The consideration received will be exempt under clause (10D) as the annual premium payable on the policy is not more than Rs 2.5 lakh.

Example-3:

An individual had bought ULIP, which satisfies all the conditions mentioned under Section 10(10D). He did not receive any consideration under any other eligible ULIPs in earlier financial years preceding the financial year 2031-32.  The details are as mentioned in the table:

Taxability as per fifth proviso under Section 10(10D) of the ITA:  

As per the rules, where multiple ULIP proceeds are received during the year, the consideration under only such eligible ULIPs (the aggregate amount of the premium payable is less than Rs 2.5 lakh for any of the financial years during their term) shall be exempt from tax under Section 10(10D).

Hence, the consideration received under ULIP Z will not be exempt under clause (10D) since the aggregate of the annual premium payable for  ULIP X, Y, and Z exceeds Rs 2.5 lakh during the term of these policies.  

The consideration received under ULIPs X and Y will be exempt under clause (10D), as the aggregate annual premium payable for the two policies is not more than Rs 2.5 lakh for any financial year during the term of these two policies. 

Example-4:

An individual bought multiple ULIPs; the details are as below.

Taxability as per fifth proviso of Section 10(10D) of the ITA:  

The consideration under ULIP A will be exempt under clause (10D) as the policy has been issued before February 1, 2021. 

The consideration received under ULIP Z will not be exempt under clause (10D) since the aggregate annual premium payable for  ULIP X, Y, and Z is more than Rs 2.5 lakh during the term of these policies.

The consideration received under ULIPs X and Y will be exempt under clause (10D) since the aggregate annual premium payable for these two policies is not more than Rs 2.5 lakh for any financial year during the term of these two policies.  

(As per the rules, where multiple ULIP proceeds are received during the year, the consideration under only such eligible ULIPs shall be exempt from tax under Section 10(10D), where aggregate of the amount of the premium payable does not exceed Rs 2.5 lakh for any of the financial years during their term).

Need for Amendment

Why did the government introduce such an amendment? Earlier, under the provisions of IAT, for any person, there was no cap on the amount of annual premium paid during the term of the policy. It was noticed that specific high net-worth individuals were claiming exemption under this clause by investing in ULIPs with a high premium.