With rising stock markets, increasing financial savings and higher risk-appetite of young investors, unit-linked insurance plans (Ulips) of life insurance companies have reported strong growth in the current financial year. In the individual regular new business, sales of Ulips grew 49% year-on-year to Rs 13,000 crore in the first nine months of this financial year. In the individual single premium new business, Ulip sales grew 85% y-o-y to Rs 4,330 crore during the same period, data from Insurance Regulatory and Development Authority of India show.
The bounce-back in Ulip sales despite the Union Budget 2021-22 eliminating the tax arbitrage between Ulips and equity mutual fund investments for high-value investors, indicates that individuals are willing to put money in life insurance for investments as they are cost-effective, secure and chances of mis-selling is less. Experts feel that the sales of Ulips will gain further momentum in the tax-saving season till March.
Should you invest in Ulips or ELSS?
Ulips are market-linked with a thin crust of life insurance. These products have a lock-in period of five years as compared with three years on equity-linked savings schemes (ELSS) of mutual funds. Moreover, in a Ulip, an investor is stuck with the same funds and fund managers for the full term of the plan. 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. Investors can select the fund mix— large-, mid- or small-cap in equity or even debt funds to invest depending on their risk appetite.
Policyholders can switch between the fund options on paying switching charges to the insurance company. However, in ELSS the investments cannot be touched till the lock-in period is over.
While the insurance regulator had capped the exorbitant front-loaded charges levied by the insurers in Ulips, the charges are still higher than equity-related investments, where the expense ratio is 1-2.5%. Insurers levy four kinds of charges in Ulips—allocation, policy administration, mortality and fund management charges. 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. So, higher charges in Ulips reduce the overall returns in the long-run.
No tax arbitrage in Ulips
Last week, the Central Board of Direct Taxes notified new norms for computation of capital gains under Ulips. The government had removed the tax exemption on maturity proceeds of Ulips with an annual aggregate premium of over Rs 2.5 lakh. The tax exemption is now only available for up to Rs 2.5 lakh investment under Section 10(10)D of the Income Tax Act. Long-term capital gains (LTCG) tax will be applicable on Ulips like all equity-oriented investments. However, there will be no tax on proceeds in case of death of the policyholder. 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.
Long-term capital gains (holding period over 12 months) over Rs 1 lakh in a financial year is taxed at 10% and short term capital gain tax at 15% is levied on overall gains (holding period less than 12 months). For equity investments related to tax-planning, experts suggest that investors must have a balanced portfolio of Ulips and ELSS for long-term returns.