Indians have adopted digitalization in the wake of the demonetization drive. This initiative has also made new investment options available for investors. Immediately after the demonetization, banks lowered the interest rates on fixed deposits [FDs], which are expected to further reduce.
Life insurance is gaining popularity while interest rates on FDs reduce. However, traditional insurance plans like money back and endowment plans do not deliver high returns on your investments.
Amongst the various types of insurance plans, Unit-Linked Insurance Plans [ULIPs] provide an excellent solution to build wealth over the long-term. The ULIP benefits include tax saving, life cover, and returns in a single financial product.
A unique feature of ULIPs is that you may choose to invest some portion of your premium in debt or equity instruments. Moreover, you may switch between one fund and another based on your changing needs. What makes ULIPs popular is that compared to most other market-related investment options the returns on such insurance plans are eligible for tax exemptions.
Financial planning and ULIPs
A robust financial plan not only includes smart ways to invest money but must also be tax efficient. Individual investors may invest in several tax-saving investments like Public Provident Fund [PPF], insurance plans, Equity-Linked Saving Schemes [ELSS], and ULIPs. To make the right investment decision, you need to consider appreciation, flexibility, wealth protection, and tax efficiency.
A regular life insurance plan offers tax benefits and life coverage but minimal returns. In comparison, mutual funds provide the opportunity to earn higher returns but with no life coverage and limited tax savings. Other options like PPF often deliver returns that are lower than the rate of inflation and do not help in wealth creation. ULIPs are an excellent option to overcome most of the limitations related to other investment products.
Tax savings on premiums
A portion of the premium paid on the ULIP is used towards offering the life coverage. The balance may be invested in debt, equity, or other money-market instruments. The amount paid as the premium is eligible for tax benefits under section 80C of the Income Tax Act. The maximum limit capped for such deduction is up to INR 1.5 lakh per annum.
The condition for the deduction
The section 80C deduction is available only if the total premium paid is less than 10% of the total sum assured under the ULIP. Here is an example to help you understand. Assume you have invested in a ULIP with a sum assured of INR 15 lakh with an annual premium of INR 1.5 lakh. This entire amount is eligible for tax deduction. However, if the premium exceeds INR 15 lakh, the deduction is capped at this maximum limit irrespective of the total annual premium amount.
Tax benefits on withdrawals
Another advantage of ULIPs that is not available if you invest in mutual funds is the benefits available on withdrawals. You may withdraw from a ULIP in three instances:
- Demise of the policyholder
- At the time of maturity
- Partial withdrawal at the end of the five-year holding period
Death benefits paid to your beneficiaries in case of your demise during the policy period are completely tax-free. The payout may be higher than the sum assured because your chosen investments may have performed well and delivered superior returns.
The maturity benefits are available at the end of the policy term. At the time of maturity, you receive the sum assured or the fund value based on the investments, whichever is higher. These maturity benefits are eligible for tax exemption under Section 10 [10D] of the Income Tax Act. In comparison, the maturity benefits on mutual funds are taxed as per your income tax slab.
In addition to the tax benefits, ULIPs provide other advantages as discussed below:
- Financial goal planning
When you invest in a ULIP, you need to remain invested for at least five years. At the end of this lock-in period, you may make partial withdrawals. However, these cannot exceed 20% of the total fund value and are not taxable.
The partial withdrawal feature may be used to meet your various financial goals at different life stages. You may use ULIPs to meet the down payment for your home or to pay children’s higher education. You may combine different financial products such as debt and equity, based on your risk appetite, to meet your life goals.
- Increased investments
If you have an investible surplus, you may easily increase your investment in the best ULIP plan. This allows you the opportunity to earn higher returns and accumulate a larger corpus over the long-term. Moreover, these increased investments are also eligible for tax exemptions under Section 80C and Section 10 [10D] provided they satisfy the condition where the total premium does not exceed 10% of the sum assured.
- Choose investment options
When you invest in a ULIP, you may choose the financial instruments to invest your money. Based on your age, financial objectives, life stage, and risk appetite, you may invest in debt, equity, or any combination thereof. You may also switch between different instruments or modify the proportionate holding in these products. This allows you to benefit from market ups and prevent your losses in case of a downturn.
Investing in different types of financial instruments is recommended to earn returns and reduce the risk of investing. However, you may lack the financial expertise and the knowledge to make accurate investment decisions. To overcome this limitation, you may invest in a ULIP that combines several features of different investment instruments.
You may compare different ULIPs to analyze various parameters and make the right investment decision. Invest in one today if you do not already have an investment in ULIPs.