Unit-linked insurance plans (Ulips) have been in the news ever since the Budget reintroduced long-term capital gains tax on equity investments. In the meantime, life insurers have carried out course correction and removed some of the shortcomings that nearly drove Ulips to extinction. Should you be interested?
The poor reputation of earlier Ulips had much to do with the high commissions paid to distributors. It has prompted sellers to push the products to policyholders who often could not take on market risks or stay invested for the long-term. The turning point came with the market crisis in 2008-09 and the India regulations of 2010. Even then, the share of Ulips in the new business premiums declined from 55% in March 2010 to 12% in December 2017. The caps on Ulip charges and five-year lock-in period came into force in June 2010.
Now, ‘reformed’ Ulips are being presented as products that can help you achieve your financial goals through disciplined investing, market-linked returns and lower charges, potentially reenergizing this segment. What policyholders save today are premium allocation charges, primarily commissions paid to distributors, which have been done away. While some companies launched products with lower premium allocation charges in 2011-12 too, they had hiked policy administration charges, shortchanging policyholders. Now, some have done away with policy administration charges along with premium allocation charges. Other features like the return of mortality charges, additional allocations by the company and loyalty additions sweeten the deal further.
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The imposition of long-term capital gains tax (LTCG) on investments in direct equities and equity mutual funds has also encouraged Ulip investors. Ulips have not been affected by this blow as they are treated as insurance products. Moreover, switching between equity and debt fund options in Ulips does not attract any tax either, unlike mutual funds. These plans score over ELSS too, since Ulip investors can redeem the entire amount at the end of five years even if the premium has been paid in installments, unlike SIP investors in ELSS.
Some old limitations remain
However, mutual funds score over Ulips regarding flexibility. You can redeem investments in an underperforming fund and switch to a better performing scheme. Ulips do not allow such mobility. Also, you can stop SIPs and exit with minimal hassles if you so wish, but not servicing your Ulip premiums could result in your policy lapsing, and surrendering the policy during the five-year lock-in period will mean shelling out discontinuance charges. Therefore, Ulips are not suitable for those who are not confident of recurring income over five to seven years or are likely to need their money in the interim. Since Ulip returns are linked to market fortunes, you will also need to have the risk appetite to stomach fluctuations.
Even on the taxation front, Ulips are not runaway winners. “Non-equity funds are eligible for indexation benefit after three years. If the returns are below inflation levels, you can claim a loss and adjust against other taxable gains, or carry forward the loss for up to eight years,” says Sudhir Kaushik, Co-founder, Taxspanner. Despite the ultra-low costs of these Ulips, most financial planners still recommend a combination of mutual funds and term insurance. “Nothing can beat a term plan when the objective is protection,” contends Pankaj Mathpal. CEO, Optima Money Managers.
How we did it
For our analysis, we considered the online Ulips with the lowest charge structure. Some Ulips with lower charges has been left out because their overall costs are higher. It was assumed that the Ulip earned 8%, in line with India rules that allow insurers to use projected returns of 4% and 8% in benefit illustrations. Using the maturity value, we computed the internal rate of return of the plans.
Key tax facts about ULIPs
Tax-free Income, gains
Ulips are insurance plans, and therefore, the income and gains are tax-free under Section 10(10d). Even short-term gains made by the policyholder by switching from one plan to another are tax-free. This gives Ulips an edge over mutual funds. However, the income and gains from the Ulip are tax-free only if the cover is 10-times the annual premium.
Adequate cover for tax benefits
The premium you pay is eligible for tax deduction under Section 80C. Here again, this benefit is available only if the cover is ten times the annualized premium. If the premium is more than 10% of the sum assured the tax deduction is allowed on the amount equal to 10% of the sum promised. For those suffering from specified illnesses or disabilities, the premium should not be more than 15% of the insurance cover. The minimum insurance cover rules do not apply to the death benefit. The insurance money received by the nominee on death of the policyholder will be tax-free in all circumstances.
No tax sop on premature surrender
A Ulip must be continued for at least five years if you want to claim the tax benefits. If the policyholder terminates the Ulip before the completion of five years, the tax deduction availed till then will be reversed. This means the entire deduction claimed on the Ulip premium will be added to the income of the policyholder in the year in which the policy is discontinued.
(As published on Times of India, May 14, 2018)