ULIPs are insurance policies that have two attached components -wealth creation and life cover.
Authored by Saumya Shah
ULIPs are insurance policies that have two attached components -wealth creation and life cover. A part of the premiums paid by each investor goes into a fund made from a pool of money received from various investors; the remaining amount goes towards the mortality charges, fund management charges and allocation charges.
The fund then invests this money in debt and equity securities. Returns vary on the performance of the funds. So, investors get the advantage of wealth creation along with the security of a life cover.
As an investor, you can choose from a mix of debt and equity securities, depending on your risk appetite and your personal financial requirements. Also, you can claim a deduction of up to Rs 1.5 lakh under section 80c on premiums paid for ULIPs; further, the maturity amount is tax free in the hands of investors.
The lock-in period with ULIPs is just 5 years and also during the period, you can shift your funds among liquid, income and equity funds without attracting any taxes on capital gains or charges like STT. Apart from that, some companies also give back their allocation charges with loyalty units if held for the entire term.
Mutual funds, on the other hand, are pools of money received by ‘Asset Management Companies’ (AMCs) from several investors. Mutual funds are professionally managed by expert fund managers. These fund managers use their expertise to invest the collected funds in equity, debt, gold, money market securities, and other investable securities.
AMCs charge a certain fee known as an expense ratio to manage the fund. Mutual fund returns vary based on the performance of the scheme and the fund manager’s judgement. Different mutual funds have different objectives and different risks associated with them. An investor should choose a mutual fund according to his risk appetite and needs.
When you invest in mutual funds, you can claim a deduction of up to ₹1.5 lakhs under section 80c, on funds invested in Equity Linked Saving Scheme (ELSS) mutual funds. ELSS mutual funds have a 3-year lock-in period.
ULIPs and Mutual Funds in context of Budget, 2021
Both, ULIPs and mutual funds are majorly sold as investment products. Until now, proceeds from a Unit Linked Insurance Policy enjoyed tax exemptions under section 10(10D) as long as the premium for any year did not exceed 10 percent of the sum assured. On the other hand, mutual funds had to pay a long-term capital gains tax of 10 percent on gains exceeding Rs 1 lakh. In addition to this, in the case of ULIPs, the sum received upon death was also fully tax-free, irrespective of the quantum of the premium paid. So, a tax parity between ULIPs and mutual funds was sought after, for a long time.
The mutual fund industry had a very clear view that tax-free returns from ULIPs gave undue advantage to ULIPs, and made them more attractive to investors. HNIs and high-income earners took advantage of this provision to park large amounts of money in ULIPs to earn tax-free returns.
Now with the new budget 2021, ULIPs will lose their undue advantage, because the Finance Minister has made an amendment to the Income Tax Act, 1961. According to the amendment, gains from a ULIP policy will be treated as capital gains if the premium paid for any year exceeds Rs 2.5 Lakhs.
These gains will also be taxed accordingly. If an investor buys different policies, the aggregate of the premium amount will be considered. Moreover, STT will also be applied upon redemption of the ULIP. ULIPs will henceforth carry the definition of an equity-oriented fund in section 112A, thereby providing ULIP units with the same treatment as units of an equity-oriented fund. Consequently, provisions of sections 111A and 112A will also be applicable on the sale/redemption of such ULIPs.
This change will be applicable to all ULIP policies issued after February 1, 2021.
Saumya Shah is the Founder of Tarrakki.com, providing comprehensive wealth management solutions. Views are personal
(Edited by : Anshul)