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Commentary

Don’t Put Too Much in ULIPs, Says Budget 2021. You’ll Be Taxed Like A Mutual Fund

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Your ULIPs – Unit Linked Insurance Plans – had a huge advantage over mutual funds or any other form of investments, in that they were tax free on exit. You could invest whatever you wanted and you would not get taxed on the gains, due to a favourable tax policy.

Not any more.

In Budget 2021, new ULIPs launched after Feb 1, 2021 will not allow such a tax exemption for people who invest a lot in them. That means if your annual premium was Rs. 2.5 lakh or more, across all the ULIPs you have invested in, then you don’t get the tax benefit on exit.

Here’s what it means:

  • You might have wanted to put more money into ULIPs because everywhere else, any exit is taxed at least 10% of profit, such as in mutual funds
  • Now if you do this for any new ULIP, your exit proceeds will be taxed on the profits only (not on the principal)
  • And not just that, you will pay STT on the exit, like in equity mutual funds.
  • This applies only if you invest Rs. 2.5 lakh or more in one or more ULIPs, in total.
  • What if you have multiple policies, where the total exceeds Rs. 2.5 lakh in premium?
  • Then you can select policies where premium, added up  in the year, add up to less than 2.5 lakh – and those are tax free on exit. Any further amount is not.
  • So if you have three policies, each with Rs. 100,000 premium, then the first two are tax-free on exit and the third is not.
  • If you have existing ULIPs, nothing changes – those continue to be tax free on exit.

How much tax? 10% of profits, as capital gains.

(No indexation of inflation is allowed, at this time)

The Caveats

Lots of rules, of course:

  • If you die, your next of kin don’t have to pay tax when they get the money, even if you cross this 2.5 lakh premium limit
  • Does not apply to “traditional” policies. Expect insurers to push more of those now.
  • Will not apply to past policies, so if you’re paying crazy premiums there, you can continue without any impact.
  • Only policies issued AFTER Feb 1, 2021 will see this as an impact.

Does it hurt insurers?

It will, to some extent, as the likes of ICICI issue a lot of ULIPs (more than 50% of their premium income is ULIPs) And then most of their premium also comes from people who pay more than 1.25 lakh per year as premium. They stand to lose considerable. Others such as LIC have more well spread out policyholders.

This will now bring mutual funds on par with ULIPs as long term investment vehicles. It’s positive for mutual funds in that respect.

If you were planning to take a ULIP, this might be one more reason to stay away from an opaque complex product – the lack of a tax benefit too.

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