Due to the introduction of LTCG (long-term capital gain tax) in the Union Budget of 2018, investors are showing a trend of moving away from Mutual Funds and investing in ULIPS (United Link Insurance Plans) due to its tax-free nature.
ULIPs and their Tax Benefits
ULIPs (United Linked Insurance Plan) are investment solutions with multiple options for investors. They provide complete investment flexibility. They are also insurance plans the premium of which can be invested in multiple funds like debt fund, equity fund and so on as per your choice. At the same time, a small part of the premium is also used towards providing life insurance cover. A ULIP is an ideal option for wealth creation due to its high returns, minimum risk, and financial security for your loved ones.
As far as tax benefits go, the money invested in ULIP is fully claimable as a deduction as per the Income Tax Act under section 80 C (life insurance) or section 80 CCC (pension). A maximum amount of Rs. 1, 50,000 is permissible under both the sections. In other words, the tax deduction of up to 10% of the sum assured or the yearly premium, whichever is lesser is allowed subject to a limit of Rs. 1, 50,000.
For the ULIP life insurance, it must be held for at least 2 years in order to claim deduction under section 80 C. On partial withdrawal or maturity of the policy, if the premium is not more than 10% of the sum assured, the amount received is exempted from tax. If the percentage exceeds 10% anytime during the term of the policy, all the future proceeds of the plan will be taxable.
During retirement on commutation, the retirement ULIP is tax-free under section 10(10 A) whereas a surrender or pension received will be taxable.
Impact of Union Budget 2018 on Taxation and Investment
In Budget 2018, Government of India proposed to re-introduce LTCG (Long-term capital gain tax) of 10 % of equity and equity-related investments that are one year or older. This is a big change as until now, investments made inequities which were known as long-term capital gains were not taxed. This will impact the Mutual Fund investment scenario to a large extent.
Mutual Funds no Longer the only Best Choice
Till now, with long-term capital gain tax being non-existent, investors could easily exit an investment any time after a year and not be liable for the tax. This easy access and exit drove investors towards Mutual Fund. Tax saving mutual funds like the Equity Linked Savings Scheme (ELSS) also worked similarly. Hence investors used to enjoy the Income Tax exemption under Section 80 C and exit after the 3-year lock-in period.
But after the new policy, these early exits would prove costly to the investor. Only when they obtain large amounts of gains will they able to exit a policy. This will, in turn, encourage them to look out for long-term investment in equities with long-term gains.
Unlike Mutual Funds, ULIPs will not be impacted by the imposition of the long-term capital gain tax. ULIPs are designed to perform like long-term investments with exits possible only after 5 years into the policy. Post Union Budget 2018, investors will learn more towards ULIPs due to the 10% long-term capital gain tax on mutual funds especially ELSS.
Even before the budget that proposed a long-term capital gain tax on Mutual Funds, ULIPs had an advantage over Mutual Funds in taxation. If equity funds were held for less than a year, a 15% short-term capital gain tax was imposed. But on the other hand, ULIPs are insurance products and hence always were tax-free under Section 10.
This advantage will become even more impactful after the LTCG tax kicked in. Insurance companies are the ones to benefit from this development. They have begun to specify that equity and balanced funds will be taxed up to 10% whereas ULIPs will be exempted from tax.
This tax-free benefit extends beyond the fixed income instruments as ULIPs offer even debt and liquid investment funds to investors. Fixed Deposit income is taxed at a nominal rate while the long-term capital gains tax stays at 20%. On the other hand, all gains from ULIPs are tax-free whether you are investing in short-term or long-term funds.
Costs of ULIPs investments are no longer a barrier for investors. Since 2010, high ULIPs were a thing of the past. In fact, the cost structure of some ULIP plans is on par with low cost direct mutual fund schemes. Online ULIPs manage low cost because they have no administrative overheads or fund allocation costs.
Buying a ULIP gives a chance for an investor to invest in both debt and equity fund based on his risk-taking ability without any tax burden. And ULIPs are a good mix of investment and insurance whereas mutual funds are for pure investment purposes.
It is obvious that the long-term capital gains tax proposal by budget 2018 will make investors re-consider their investment options especially if they want tax saving with growth to be a part of the plan. ULIPs are a perfect choice to fit this requirement.