Unit Linked Insurance Plan: What Taxpayers Must Know
Updated: Oct 2
The appeal of market-linked returns cannot be ignored by Indian taxpayers. There are high returns which are also in alignment with the expansion in the economy. Life insurance companies launched unit-linked life insurance plans termed ULIPs. The main aim is to tap into the lucrative returns promised by the stock market. ULIPs are life insurance policies that invest the premium in the capital market and provide you with market-linked returns. What could be more exciting than receiving a tax benefit at the same time? A unit-linked plan offers both insurance coverage and capital market returns. In this guide, you will grasp how ULIP operates and its main characteristics.
Table of Contents
What is the ULIP Plan?
A ULIP (Unit Linked Insurance Policy) is a financial product that incorporates the advantages of investing and insurance. It was established in an effort to increase the rate of return on insurance premiums. In ULIPs, a part of the premium is added in life insurance, while most of it is invested directly or indirectly in the stock market. For example, suppose you invested in an insurance policy with a 10-year maturity period, after which you will receive a fixed amount. In this instance, the amount to be received at maturity remains fixed. Conversely, in the case of a ULIP, the maturity amount is determined by the performance level of the market in which the premium is invested.
How Does ULIP Work?
When you put money in a ULIP, the insurance company invests a part of the payment in shares/bonds. Moreover, the remainder is used to provide insurance coverage. Fund managers at insurance companies manage the investments, saving the investor the burden of tracking them. ULIPs allow you to convert your portfolio between debt and equity based on your risk tolerance and understanding of market performance. Benefits such as these, which allow investors to switch, play a significant role in the popularity of various investment products.
Features of ULIP
ULIPs differ from other types of life insurance policies. They offer a variety of unique features, making the plan extremely adaptable. These distinct characteristics are as follows:
Partial withdrawals: Partial withdrawals allow you to withdraw a portion of your fund's value. After the 5-year lock-in period, your fund's value can be utilised to address immediate financial needs. ULIPs provide convenient liquidity by allowing you to make partial withdrawals. The quantity of partial withdrawals you can make from your fund's value is limited. Typically, ULIPs demand that you keep at least one yearly premium in the fund value at all times after making a withdrawal.
Switching: Switching refers to transferring your invested premium from one fund to another. Once you have decided on a fund to put your premium in, the decision is not final. You can alter investment funds whenever you wish by utilising the switching facility. Switching allows you to adjust your investment strategy in response to market changes. For example, if you have invested in debt funds and the equities market is expanding, you can convert your fund value from debt funds to equity funds to capitalise on the increase. Similarly, if the stock market is volatile and you want to preserve your investments, you can convert from an equity fund to a debt fund. Switching is allowed without restriction.
Top-up: A top-up is defined as an extra premium paid above and beyond the plan's actual premium that you wish to put in the fund of your unit-linked plan. When your ULIP is providing excellent results, you may want to increase your investments to produce even larger profits. Top-ups allow you to enhance your investment by paying additional premiums. Furthermore, every top-up in your unit-linked plan will be accompanied by a sum assured. As a result, top-up investments would boost both your plan's aggregate sum promised and fund value.
Premium redirection: Premium redirection is synonymous with switching, but not the same. Switching occurs when you withdraw your investment from one fund and place it in another. Future premiums are redirected to another fund in the case of premium redirections. As a result, the previously paid premiums stay invested in the funds you selected. Only fresh premiums are diverted and invested in another fund.
Settlement Option: When the plan reaches maturity, you have the option to settle. The settlement option allows the policyholder to receive the maturity proceeds in five equal instalments spread over five years after maturity. So, you can choose to withdraw the maturity value in increments while leaving the fund value to grow over the next five years. This usually happens if the fund is performing well and you wish to stay invested in the plan.
Types of ULIP
ULIPs are classified in accordance to a broad criterion which is stated as follows:
Funds that ULIP invests in:
Equity Funds: Where the premium is invested in the equity market, the risk becomes high.
Balanced funds: Where the premium paid is split across the debt and equity markets to reduce risk for investors.
Debt Funds: The premium is invested in debt securities, which have a lower risk but also deliver a lesser return
End Use of Funds
Retirement Planning: It is for those who intend to invest for retirement while still employed.
Child Education: You can invest with the long-term purpose of saving for your child's education or to cover unexpected expenses.
Wealth Creation: You can invest to establish a large corpus that you can use for a future financial goal.
Death benefit to policyholders
Type I ULIP: In the event of the policyholder's death, the nominee receives the higher of the insured sum value or the fund value.
Type II ULIP: This pays the assured sum plus the fund value to the nominee in the event of the policyholder's death.
Steps to Invest in ULIP
Step 1: Conduct market research on ULIP products and create a list of all available options from various providers.
Step 2: Learn about the life insurance features and investment profiles of each ULIP product.
Step 3: Select the package that best meets your investing and insurance needs.
Step 4: Contact the relevant insurer online or in-person to learn more about the package.
Step 5: Buy the ULIP product from the insurer if you are satisfied.
Benefits of Investing in ULIPs
Life cover:
First and foremost, ULIPs provide life insurance as well as investing opportunities. It provides a safety net for a taxpayer's family in the event of an emergency, such as the taxpayer's premature death.
Income Tax Benefits:
Few people are aware that the premium paid for a ULIP is qualified for a tax credit under Section 80C. Additionally, Section 10(10D) of the Income-tax Act exempts the policy's maturity returns from income tax. This policy allows you to claim a dual benefit.
Financial Long-Term Goals:
You might have long-term goals such as buying a house, a new automobile, getting married, and so on. ULIPs are a smart investment option because the money compounds. With ULIPs, the aim is to always maintain the policy in place for a longer period of time to reap the maximum benefit.
Flexibility:
As previously said, ULIPS are often structured to allow you to switch between debt and equity based on your risk tolerance and knowledge of market performance. On the other hand, insurance companies allow just a limited number of switches free of charge.
Risks Associated with ULIPs
The risk connected with ULIP plans varies depending on the sort of fund attached to them. For example, an equity fund is risky in comparison to a debt fund. On the other hand, a balanced fund spreads risk across both stock and debt portfolios. The ULIP plan will involve the appropriate risk factor. In addition, ULIPs are riskier than other types of investments. Likewise, ELSS (Equity Linked Savings Scheme), which is also covered by section 80C, is a better diversified and less hazardous investment. When compared to a standalone insurance plan or a mutual fund product, ULIPs have higher risks. The cost structure of ULIPs makes it pricey, and it is tough to obtain returns that will cover your costs and allow you to add on top of that. Given the higher cost of ULIPs, it can be concluded that the risk factor is greater.
Fees and Charges of ULIP Investment
There are a variety of fees associated with each investment. The charges for a ULIP can be broadly classified as follows:
Premium Allocation Charge:
The Premium Allocation Charge is a predetermined percentage taken from the premium paid in the first years of the policy. This is charged at a higher rate. The fees cover the startup and renewal costs, as well as the middleman commission expenses. It is a front-load charge. This means that it is subtracted from your premium payment.
Mortality Charges:
This fee is used to cover the plan's insurance costs. Mortality charges depend on various parameters. These include age, the sum assured, and are deducted monthly.
Fund Management Charges:
The Fund Management Charge is a cost charged by the insurance provider for the management of the various funds in the ULIP. It is levied for fund management and deducted prior to calculating the NAV. The maximum annual charge allowed is 1.35 percent of the fund's value, which is levied daily. In general, insurers charge the maximum amount allowed in equity funds, while non-equity funds are charged far less.
Partial Withdrawal Charge:
ULIPs allow for partial withdrawals of funds. Some plans allow limitless withdrawals, while others limit them to 2-4 withdrawals. These withdrawals can be free up to a particular amount, or you may be charged based on your transaction history.H4 - Switching funds: The process of shifting funds or investments between choices is known as switching. There are alternatives to swap your money for free up to a certain amount per year. Any additional modifications may result in a fee of Rs. 100 - Rs. 250 per swap.
Policy administration charges:
This charge is levied for policy management and is deducted on a monthly basis by cancelling units from all funds specified. This fee might be assessed at a fixed amount or as a percentage of your premium.
Lock-In Period of ULIPs
In 2010, the Insurance Regulatory and Development Authority of India (IRDAI) increased the lock-in duration for ULIPs from a period of three years to five years. However, because insurance is a long-term product, as an investor, you may not fully benefit from the policy unless you hold it for the entire term, which can vary from 10 to 15 years.
How to Decide the Best ULIP
There are numerous ULIP products available on the market. You need to keep in mind the following elements to know the best ULIP product to put your money in:
Total Cost of ULIP Investment:
When you sign up for a ULIP product, you will be charged various types of fees. This includes mortality charges, premium allocation charges, fund management fees, policy charges, and surrender charges. Since all of these fees and levies are offset by returns, it is advised that you choose a low-cost ULIP.
Fund Options and Returns:
ULIPs offer three main fund options: equities, debt, and balanced funds. Each of these fund options has a different return structure. It is essential that you research the type of fund available under your ULIP option, as well as the returns they provide. This must be thoroughly sorted out before paying the premiums.
Loyalty Bonus:
Some ULIPs offer additional units subject to specified circumstances. These perks can increase your returns if you stay invested for a long time. Select the ULIPs that provide loyalty bonuses and other similar advantages.
Switching Options:
Some ULIP products offer the possibility to switch up to four times. Some other ULIP solutions offer limitless switching choices. Keep an eye out for this feature because switching allows investors to better analyse the performance of their present funds and move their investment to a better-performing fund.
Premium Payment:
There may be many premium payment alternatives available, as well as flexibility in payment frequency. Check to see if the ULIP that you have selected offers flexible premium payments that are compatible with your financial situation.
ULIP Tax Rules and Implications
Premium Payment Tax Benefits:
The insurance premiums paid for ULIPs are eligible for an income tax deduction under Section 80C of the Income Tax Act, up to a maximum of Rs 1.5 lakh annually.
Maturity Proceeds' Taxability:
Your ULIP is tax-free if your policy is issued on or after February 1, 2021. This is also applicable if you have an annual premium of less than Rs 2.5 lakh and a premium of no more than 10% of the sum guaranteed. If you paid a ULIP premium of Rs 2.5 lakh or more for a policy purchased on or after February 1, 2021, the returns on that ULIP, i.e. the maturity amount received (including bonus), are subjected to taxes.
Furthermore, remember that returns on any ULIPs purchased between April 2012 and February 2021 are totally tax-free provided the premium was less than 10% of the sum insured. The maturity amount of ULIPs purchased before April 2012 is tax-free if the premium was less than 20% of the sum insured.
Death Benefit Tax Exemption:
The maturity amount received at the policyholder's death is tax-free. Section 10(10)D of the Income Tax Act exempts the death benefit from taxation.
Withdrawals/Surrender Tax Implications:
If you remove the ULIP before the five-year lock-in period expires, the surrender value is considered income and is taxed accordingly. Keep in mind that if the premium exceeds 10% of the total insured, Tax Deducted at Source (TDS) will also apply to the surrender value of the ULIP.
Tax Benefits of ULIP
Eligibility for ULIP tax benefits under Section 80C of the Income Tax Act:
The premium payment is the largest ULIP tax benefit. The insurance premiums paid for ULIPs can be claimed as tax deductions. This is in accordance with Section 80C of the Income Tax Act, up to a total of Rs 1.5 lakh per year.
Tax exemption on ULIP death benefits under section 10 (10D):
No matter how much premium you pay for a ULIP, the maturity amount received upon the policyholder's death is completely tax-free. The death benefit remains are exempt from ULIP taxes under Section 10 (10D) of the Income Tax Act.
Tax Planning Strategies with ULIP
Some useful techniques to assist you with your ULIP tax planning are stated as follows:
Maximise the benefits available under Section 80C. The main tax benefit for ULIPs is that the premium paid is eligible for an annual deduction of up to Rs 1.5 lakh under Section 80C. Maximise this tax benefit because it can greatly reduce your tax liability for that fiscal year.
Use tax-free maturity. Except for ULIP plans with annual premiums of Rs 2.5 lakh or more and purchased after February 1, 2021, all other ULIP plans have a tax-free maturity as long as the premium does not exceed the determined percentage of the total guaranteed. Make sure you're aware of this perk and whether your ULIP qualifies for it.
Also, use the ULIP's fund-switching facility to transfer to funds that offer better tax efficiency for ULIPs.
Comparison of ULIP With Other Investments for Sec 80C
Particulars | ULIPS | ELSS | PPF |
Lock-in period | 5 years | 3 years | 15 years |
Tax benefits | 80C and returns on maturity are exempt under Sec 10 (10D). | 80C | 80C and maturity amount is tax-exempt |
Taxation | Gains are taxable based on underlying asset | Gains above Rs 1 lakh in a financial year taxable under LTCG at 10% | None |
Underlying assets | Debt, equity and balanced | Equity | Fixed-income oriented |
Risk | Highest among the lot | Not as risky as ULIPS | Risk-free with guaranteed returns since it is backed by the government |
Charges | Premium allocation charge Switching charge Surrender charge Mortality charge Policy administration charge | Expense ratio in the range of 1.05 to 2.25 | One-time account opening charge of Rs 100 |
Conclusion
ULIPs are an obvious choice for investors looking for high returns while also protecting their family's financial future with life insurance. ULIPs offer tax-free maturity in most circumstances, totally tax-free death benefits, and tax benefits under Section 80C for premium payments. Therefore, they are an appealing method for those wishing to reap the benefits of both an investment plan and insurance coverage. You need to make sure you are aware of the ULIP tax rules and perks to maximise them.
FAQ
Q1. What is Unit-linked life Insurance?
A ULIP is a type of life insurance that is provided to the bearer to cover risks. In addition, holders can benefit from investing in other qualifying investments such as bonds, mutual funds, and equities.
Q2. What is a unit in ULIP?
An insurer pools money from policyholders in the form of premiums and invests it in the funds they choose. Once the money is invested, the total invested corpus is divided into 'units', each with a specific face value. Furthermore, each investor is assigned 'units' based on the amount invested by each. The Net Asset Value (NAV) is the value of each unit at any given point in time.
Q3. When was ULIP introduced in India?
Unit Trust of India (UTI) introduced ULIPs to India in the year 1971. The Life Insurance Corporation of India (LIC) then released further ULIP policies in 1989.
Q4. Which organisations issue ULIP?
In general, public and private sector insurance providers offer ULIP products to their consumers. This happens either independently or in collaboration with overseas insurance organisations. Offering ULIP products needs a permit from both the Reserve Bank of India (RBI) and the Insurance Regulatory and Development Authority of India (IRDAI).
Q5. What is the LIC ULIP policy?
The Life Insurance Corporation (LIC), a public sector insurance corporation in India, provides three ULIP products. These products are:
Nivesh Plus
SIIP
New Endowment Plus.
Q6. What is ULIP’s lock-in period?
The ULIP's minimum lock-in duration was formerly set at three years. However, it has now been extended to five. This will result in a five-year fee allocation that is equitable.
Q7. Can ULIP be surrendered before the lock-in period?
ULIP's lock-in period has been extended to five years. You will also need to submit the charges if you intend to surrender your ULIP before the five years have passed. However, the money will be reimbursed after the lock-in period has ended.
Q8. What does ‘Fund value’ mean under ULIP?
The total amount of money that the holder wishes to invest is known as the "fund value" under ULIP.
Q9. How do you compute the fund value in a ULIP?
The entire monetary value of the policyholder's units is referred to as the fund value of the ULIP plan. The net asset value of each unit and the total number of units held can be multiplied to get an estimate of the fund worth on any given day.
Q10. When should I consider investing in ULIPs?
ULIP plans should be investigated by those with long-term financial plans for insurance and wealth growth. However, there is not a single ideal age to invest in ULIPs. ULIP can be helpful whether you are saving for retirement, your children's education, or other financial objectives. It is because it lets you grow your money while safeguarding your family against unexpected expenses.
Q11. What can I do to maximise my ULIP returns?
As an investor, optimising returns depends on your risk tolerance and financial goals. In order to get the most out of your ULIP plan, you can usually keep an eye on market fluctuations and make appropriate financial transfers.
Q12. How is ULIP structured?
You must pay an initial premium and then yearly, semi-annual, or monthly premiums if you choose to invest in ULIPs. They provide you the choice to invest in debt funds that provide consistent returns, equity funds that offer big returns, or a combination of both. This is based on your investing requirements and risk tolerance.
Q13. What is ULIP NAV?
Section 80C of the Income Tax Act, 1961 allows for a deduction of up to ₹ 1.5 lakh for premium payments made under the insurance. Section 10(10D) of the Income Tax Act, 1961 exempts returns received under the policy, subject to certain criteria. The net worth of the units held within the ULIP after relevant fund management fees and operational costs are subtracted is known as the ULIP Net Asset Value or NAV. Liabilities such as running costs and management fees are subtracted from the total worth of the units to determine it.
Q14. Why should you invest in ULIPs?
A universal life insurance plan, or ULIP, provides both investing opportunities to meet long-term objectives and life insurance to protect your loved ones' finances in the event of an untimely death. ULIP returns are correlated with the market. You can increase the returns on your assets by using the appropriate plan and investing strategy.
Q15. Is the maturity amount from ULIPs taxable?
There is no due of tax if you have a ULIP that was issued on or after February 1, 2021, and you pay a yearly premium of less than Rs 2.5 lakh, or 10% of the value assured. The returns on that ULIP, or the maturity amount received (including bonus), would be taxable if you had paid a premium of Rs 2.5 lakh or more for a policy introduced on or after February 1, 2021. Furthermore, you need to keep in mind that if the premium paid for any ULIP was less than 10% of the total guaranteed, returns on any policy bought between April 2012 and February 2021 are fully tax-free. If the premium was less than 20% of the amount insured, the maturity amount of ULIPs bought before April 2012 was free of tax.
Q16. Are ULIP premiums tax-deductible?
Under Section 80C of the Income Tax Act, the insurance premium paid toward ULIPs is deductible from taxes up to a total of Rs 1.5 lakh annually.
Q17. What are the tax implications of surrendering a ULIP policy?
The surrender value of a ULIP policy is subject to income taxation based on the appropriate income tax bracket if the policy is surrendered before the five-year lock-in period ends.
It is important to remember that if the premium exceeds 10% of the guaranteed amount, Tax Deducted at Source (TDS) would also be applied to the ULIP surrender value.
Q18. Will the tax liability apply to a ULIP plan bought before February 1, 2021?
No, you would not be responsible for paying taxes on any ULIP investments you make before February 1, 2022.
Q19. What is a Keyman insurance policy?
Employers pay the premiums for Keyman insurance policies. Moreover, employees who have significant responsibilities or unique abilities and make major financial contributions to the company are the beneficiaries. An example of a Keyman insurance policy would be one in which the policyholder pays the premium on behalf of the managing director of the company. Furthermore, these insurance policies are not exempt from Section 10(10D) requirements. The employer receives the claim amount in the event of the insured employee's death.
Q20. How to claim tax benefits on ULIPs?
Section 80C of the Income Tax Act, 1961 allows for a deduction of up to ₹ 1.5 lakh for premium payments made under the insurance. The Income Tax Act of 1961's Section 10(10D) places restrictions on the exempt status of returns received under the policy.
Q21. What is the switch option?
The ULIP's "switch" feature lets you transfer funds between debt and equity funds and vice versa, as the name implies. You can take this action if, during the policy's term, your financial objectives or risk tolerance change. Typically, a predetermined quantity of switches. Insurers permit up to two or three switches at no cost. If the number of switches exceeds that threshold, there may be a price.
Q22. What is the maturity benefit when a ULIP matures?
The sum provided by the insurer to the policyholder in the event that they live over the policy's maturity period is known as a maturity benefit under universal life insurance. The amount of the fund value is equivalent to the maturity benefit.
Q23. How to cancel/stop a ULIP policy?
Making a surrender request to your insurer will allow you to cancel the ULIP policy. When the ULIP policy is surrendered, there will be some fees. You will get the surrender value when you turn in the policy, based on the fund value on the surrender date. However, you will not get this money until your policy's five-year lock-in period has ended. For the best returns, experts recommend investing for a minimum of ten years, even though you can terminate the insurance at any time throughout the policy period.
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