Investing in Unit Linked Insurance Plans (ULIPs) involves taxes on potential gains you earn, depending on certain factors. Long-Term Capital Gains Tax (LTCG) applies if you sell your ULIP units after holding them for at least 1 year. For ULIPs purchased on or after February 1, 2021, only gains exceeding ₹2.5 lakhs per year are taxed at 10%. For older ULIPs or those with lower premiums, different rules might apply. If the policyholder passes away, no tax is levied on the maturity benefits paid to the beneficiaries.
Unit Linked Insurance Plans, or ULIPs, have gained popularity as a hybrid investment product that combines insurance and investment components. One of the key factors that investors often consider is the tax treatment of gains from ULIP sales, which offer excellent returns on investment and tax exemptions. Understanding the tax implications of financial investments is crucial for making informed decisions.
Basics of a ULIP Plan
A Unit Linked Insurance Plan includes insurance and investing in one package. The purpose of ULIPs is to cater to wealth creation and life insurance, with the insurance company investing a portion of your money in life insurance and the balance in a fund that is based on debt, equity or both and meets your long-term aims. These objectives might include retirement preparation, children’s education fees, or any significant event for which you want to save.
Taxability and Charges of ULIP on Surrender
ULIP surrender taxation is rather easy to understand. If the insurance is surrendered after the 5-year lock-in term, the surrender value is tax-free, and the insured can take advantage of the tax incentive. If you surrender your ULIP before five years, the taxability of ULIP on surrender value is added to your income and taxed at the applicable slab rate.
The return earned on ULIP investments with an annual premium of more than ₹2.5 lakh (i.e., high-value premium insurance) would not be tax-deductible, according to ULIP’s taxable budget 2023. The Central Board of Direct Taxes (CBDT) has released a notification that explains how capital gains on ULIPs will be calculated. The CBDT’s (Central Board of Direct Taxes) fundamental structure treats all payments the policyholder receives as income, whether they are for withdrawal or as an incentive.
What is Capital Gains Tax?
The Central Government imposes taxes on profits derived from the sale of movable and immovable capital assets, such as buildings, land, gold, and mutual funds, held for a specific duration. This tax, applied to the gains from your capital assets, is referred to as Capital Gains Tax.
What are the Types of Capital Gains Taxes?
In India, there are two main types of capital gains taxes: Short-term Capital Gains Tax (STCG Tax) and Long-term Capital Gains Tax (LTCG Tax). Each type has different tax rates and applies to different asset classes.
Short-Term Capital Gains Tax (STCG Tax)
STCG tax applies to profits made from selling a capital asset within one year of purchasing it. The tax rate depends on whether the Securities Transaction Tax (STT) is applied or not:
- If STT applies, the tax rate is 15%.
- If STT does not apply, the STCG tax rate is your income tax slab rate.
Long-Term Capital Gains Tax (LTCG Tax)
Long-Term Capital Gains taxes are applied to profits made from selling a capital asset after one year of purchasing it. However, for equity shares and units of equity-oriented mutual funds, the holding period is 3 years. The tax rate varies depending on the asset class:
- For most assets, the LTCG tax rate is 20%.
Equity shares and units of equity-oriented mutual funds:
- LTCG tax rate is 10% on gains exceeding Rs. 1 lakh.
- For remaining gains, the regular 20% LTCG tax applies.
What Constitutes ULIP Capital Gains Tax?
The government imposes a tax on the profits earned from the sale of movable and immovable (e.g. building, land, gold, and mutual funds) capital purchases after holding them for a specific time. Let us take a quick look at what is included under the ULIP Capital Gains Tax:
- Accrual of profits is possible upon the sale of equity-linked mutual fund assets within the ULIP Plan over a certain duration.
- The government imposes a ULIP Capital Gains Tax on the profits generated from the disposition of these capital assets.
- In the context of ULIPs, a Long Term Capital Gain (LTCG) Tax is applicable when you liquidate your assets after holding them for 1 year or more.
- No tax liability is incurred in the event of the policyholder’s demise.
Examples of ULIP Capital Gains Tax Calculation
1. Short-Term Capital Gains (STCG) Calculation
Let us assume Mr. Sharma invests in a ULIP and decides to surrender the policy after holding it for only 2 years. The taxability of ULIP on surrender value is ₹1,50,000, and the premium paid annually is ₹50,000.
ULIP Surrender Value: ₹1,50,000
Premium Paid: ₹50,000 per year for 2 years = ₹1,00,000
Short-Term Capital Gain (STCG) = Surrender Value - Premium Paid
STCG = ₹1,50,000 - ₹1,00,000 = ₹50,000
For short-term capital gains on ULIPs, the tax rate is as per the individual’s income tax slab. Let’s assume Mr. Sharma falls into the 20% tax bracket.
Short-Term Capital Gains Tax = STCG * Tax Rate
Tax = ₹50,000 * 20% = ₹10,000
So, in this example, Mr. Sharma would be liable to pay ₹10,000 as short-term capital gains tax on the ULIP surrender.
2. Long-Term Capital Gains (LTCG) Calculation
Now, consider Ms. Patel, who has held a ULIP for over 5 years and has decided to withdraw the maturity amount. The maturity value is ₹2,50,000, and the annual premium paid is ₹40,000.
ULIP Maturity Value: ₹2,50,000
Premium Paid: ₹40,000 per year for 6 years = ₹2,40,000
Long-Term Capital Gain (LTCG) = Maturity Value - Premium Paid
LTCG = ₹2,50,000 - ₹2,40,000 = ₹10,000
For long-term capital gains on ULIPs, the tax rate is 10% without the benefit of indexation.
Long-Term Capital Gains Tax = LTCG * Tax Rate
Tax = ₹10,000 * 10% = ₹1,000
In this scenario, Ms. Patel would need to pay ₹1,000 as long-term capital gains tax on the ULIP maturity amount.
What are the Factors Affecting ULIP Taxation Gains?
The tax treatment of the ULIP gains depends on various factors, including the duration of the policy and the premium amount. Here are the key points to consider:
Date of ULIP Issue
- ULIPs issued before February 1, 2021, enjoy tax-free maturity benefits and death benefits under Section 10(10D) with specific conditions.
For ULIPs issued on or after February 1, 2021:
- Less than ₹2.5 lakh across all ULIPs in any year - Entire maturity benefit tax-free under Section 10(10D).
- Exceeds ₹2.5 lakh in any year - Maturity benefits from ULIPs with less than ₹2.5 lakh annual premium remain tax-free, while others are taxable.
- Death benefit: Remains tax-free for the beneficiary regardless of issue date.
Investment Allocation
For Equity-oriented schemes (EOS):
- For ULIPs issued after February 1, 2021, an LTCG of 10% applies to gains exceeding ₹1 lakh on investments held less than 5 years.
- No tax on long-term gains exceeding ₹1 lakh.
Debt-oriented schemes (DOS):
- For ULIPs issued after February 1, 2021, LTCG of 20% with indexation benefit applies to gains exceeding ₹1 lakh on investments held less than 3 years.
- Long-term capital gains exceeding ₹1 lakh are taxed at 20% without indexation.
Type of Benefit Received
- Maturity benefit: Subject to taxation based on factors mentioned above (date of issue, premium amount, investment allocation).
- Death benefit: Always tax-free for the beneficiary.
Partial withdrawals:
- For ULIPs issued before February 1, 2021, tax-free up to the sum assured after completing 5 years.
- ULIPs issued after February 1, 2021, are subject to capital gains tax based on investment allocation and holding period.
Premium Amount
The annual premium limit of ₹2.5 lakh (combined for all ULIPs) plays a crucial role in determining the taxability of maturity benefits in ULIPs issued on or after February 1, 2021.
Policy Term
Holding period of investments affects LTCG tax rates:
- Less than 3 years (DOS) or 5 years (EOS) - Short-term capital gains tax applies.
- More than 3 years (DOS) or 5 years (EOS) - Long-term capital gains tax applies with potential exemptions/benefits.
Final Thoughts
The gains from ULIP sales are generally tax-free after the completion of the mandatory lock-in period. However, surrendering the policy before the lock-in period may attract taxation on the gains. Policyholders should carefully read the terms and conditions of their ULIPs and stay updated on any changes in tax regulations to make informed decisions. Consulting with a financial advisor is advisable for personalized guidance based on individual financial goals and circumstances.
Key Takeaways
- Surrendering before five years results in the surrender value being added to income and taxed at applicable slab rates.
- ULIPs with an annual premium over ₹2.5 lakh have non-tax-deductible returns as per the taxable budget 2023.
- LTCG Tax applies to assets sold after one year, with different rates for various asset classes, including a 10% rate on equity gains exceeding ₹1 lakh.
- ULIPs issued after Feb 1, 2021, have different tax implications based on premium amounts, investment allocation, and holding periods.
