You work hard to earn money and save for your future. But do you know how much tax you pay on your income and investments? To slash your tax liability and build your wealth, consider investing in a Unit Linked Insurance Plan (ULIP). If you are still in doubt about ULIP tax benefits, read this article to the end and get your doubts cleared.
What is a ULIP?
If you are wondering what is ULIP, it is a hybrid plan that incorporates insurance and investment. It offers you a life cover along with the opportunity to invest in various funds such as equity, debt, or balanced funds. You can choose the fund option that suits your risk appetite and financial goals.
A ULIP policy has a lock-in period of five years, which means you cannot withdraw your money before that. However, you can switch between funds during the policy term without tax implications. This allows you to adjust your portfolio according to the market conditions and changing needs.
How does a ULIP help you save tax?
A ULIP offers you multiple tax benefits under different sections of the Income Tax Act 1961. Here are some of them:
- Deduction under Section 80C: You can claim a deduction of up to Rs. 1.5 lakh for the premium paid towards a ULIP under Section 80C. This reduces your taxable income and, hence, your tax liability. However, the premium should not exceed 10% of the sum assured for plans rolled out on or after April 1, 2012. For policies issued before that date, the limit is 20% of the sum assured.
- Exemption under Section 10(10D): The maturity proceeds or the death benefit received from a ULIP are exempt from tax under Section 10(10D), provided the premium does not exceed the abovementioned limits. That means you do not have to pay any tax on the returns from your ULIP investment.
- No tax on fund switches: As mentioned earlier, you can switch between funds in a ULIP without any tax implications. Unlike mutual funds, where you have to pay capital gains tax on switching or redeeming units, ULIPs do not attract any such tax. This allows you to maximise your returns by moving your money to the best-performing funds.
However, there is one exception to these tax benefits. The Finance Act 2021, introduced a new provision that makes ULIPs taxable if the annual premium exceeds Rs. 2.5 lakh in any year of the policy term. In such cases, the maturity proceeds or the death benefit will be treated as capital gains and taxed accordingly. This provision applies to policies issued on or after February 1, 2021.
Example of tax saving through ULIP
Let us take an example to understand how ULIPs can help you save tax. Suppose you are a salaried individual with an annual income of Rs. 10 lakh. You invest Rs. 1 lakh in a ULIP with a coverage of Rs. 10 lakh and a policy term of 10 years. You choose an equity fund option for your ULIP investment.
Assuming an annual return of 12%, your ULIP investment will grow to Rs. 17.54 lakh at the end of 10 years. You will also get a life cover of Rs. 10 lakh in case of your untimely demise.
Now, let us see how much tax you can save by investing in a ULIP.
- Under Section 80C, you can get a deduction of Rs. 1 lakh for the premium paid towards the ULIP. This will reduce your taxable income to Rs. 9 lakh and your tax liability to Rs. 1.12 lakh (excluding cess and surcharge).
- Under Section 10(10D), you will not have to pay any tax on the maturity proceeds of Rs. 17.54 lakh. This will save you Rs. 2.63 lakh in tax, assuming a long-term capital gains tax rate of 10% for equity investments.
- You will also not have to pay any tax on the fund switches that you may make during the policy term.
Thus, by investing in a ULIP, you can save Rs. 3.75 lakh in tax over a period of 10 years. This is equivalent to a 21.4% return on your investment, apart from the actual returns from the fund.
ULIPs are one of the best ways to minimise your tax liability and maximise your wealth. They offer you the dual benefit of insurance and investment, along with multiple tax advantages. However, you should choose a ULIP that suits your risk profile, financial goals, and budget. You have an option to pick from equity, bonds, or balanced funds. Equity-oriented ULIP is for risky investors, while the latter two are meant for conservative investors. You should also compare the features, charges, and performance of different ULIPs before investing in one.