Union Budget 2021: Ulips lose sheen with tax on maturity proceeds

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February 3, 2021 1:35 AM

Union Budget 2021 India: Maturity proceeds of Ulips with annual aggregate premium above `2.5 lakh will now be liable for long-term capital gains tax bringing these at par with all equity investments

Amit Maheswari, tax partner, AKM Global, says in case of premium payable for more than one Ulip, exemption shall be available only if aggregate of all such premiums doesn’t exceed Rs 2.5 lakh.

Indian Union Budget 2021-22: In order to eliminate the tax arbitrage between unit-linked insurance plans (Ulips) and equity mutual fund investments for high-value investors, the government has removed the tax exemption on maturity proceeds of Ulips bought after February 1, 2021 with an annual aggregate premium of over Rs 2.5 lakh. The gains will now be subjected to long-term capital gains (LTCG) tax applicable to all equity-oriented investments. However, there will be no tax on proceeds in case of death of the policyholder.

LTCG from equity-oriented investments with holding period of over one year are taxed at 10%. In fact, Ulips are market-linked with a thin crust of life insurance and have a lock-in period of five years. The amount invested in Ulips is eligible for tax deduction under Section 80C subject to a maximum of Rs 1.5 lakh a year but with the condition that premium should not exceed 10% of the sum assured.

Level playing field
At present, maturity proceeds of life insurance policies are exempt from tax under Section 10 (10D). The government in 2018 re-introduced10% tax on LTCG above Rs 1 lakh from sale of listed equity shares. For the interest of the retail investors, experts have been asking for a level playing field between equity-mutual funds and Ulips.

Aditya M Agarwal, partner, Mahesh K Agarwal & Company, says as the Budget proposed tax on the maturity proceeds of Ulips, it will encourage people to consider insurance first for protection and then for investment. “At present, high net-worth individuals invest high premiums in Ulips as the proceeds are tax-free.

Allowing tax exemption of maturity proceeds with large premiums defeated the legislative intent of the clause. However, in order to keep the real intention of the clause which was providing benefit to small and genuine cases, the proceeds received on the death of the individual by its nominee will be tax-free,” he says.

Amit Maheswari, tax partner, AKM Global, says in case of premium payable for more than one Ulip, exemption shall be available only if aggregate of all such premiums doesn’t exceed Rs 2.5 lakh. “Ulips for which no exemption is allowed on maturity as per the above provisions would be treated as capital asset and Section 112A as applicable to listed equity shares and equity-oriented mutual funds shall be applicable,” he underlines.

A note from Axis Securities says investment in Ulip, above the specified amount, will be treated as a capital asset which could be negative for life insurance companies have high Ulip exposure (like ICICI Prudential) as it may affect the demand in HNI category.

Tax arbitrage pushed Ulips
After the introduction of LTCG tax on equity and equity-related investments in 2018, insurance firms have been aggressively selling Ulips as it is an exempt-exempt-exempt product like Public Provident Fund or Employees’ Provident Fund. Investors can select the fund mix— large-, mid- or small-cap or even debt fund to invest depending on their risk appetite. In fact, Ulips allow policyholders to switch between the fund options on paying switching charges to the insurance company.

With the tax arbitrage gone now, experts say the real benefit in terms of investment will reduce in Ulips. Moreover, the cost structure of Ulips is higher than equity mutual funds, which reduce the value of the fund in the long-run. In equity-related investments, the expense ratio of mutual funds is one of the lowest at 1.5-3%. A decade ago, the insurance regulator capped the exorbitant front-loaded charges levied by the insurers. It capped the charges and net reduction in yield for the customers.

Insurers levy four kinds of charges in Ulip —allocation, policy administration, mortality and fund management charges. The fund management charges are capped at 1.35%. Insurers deduct premium allocation charges to recover the costs incurred in processing the policy such as underwriting, medical examinations and distributor fees directly from the premium.

Experts say after the new changes in the budget, individuals should opt for a pure term insurance plan to cover the life risk and protect the family. For investments, he should look at equity mutual funds for higher long-term returns.

Maturity proceeds received on the death of the individual by his nominee will be tax-free
The move will encourage people to go for a pure term insurance plan for risk cover and invest in equity MFs for higher long-term returns

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