Comparing ULIPs and Traditional Insurance Plans

Key features:

• Market-linked returns: A portion of the premium is invested in market instruments like equities, bonds, or a mix of both. Returns are subject to market performance.
• Flexibility in investment: ULIPs allow policyholders to switch between funds (e.g., equity, debt) based on market trends or risk appetite.
• Partial withdrawal options: ULIPs provide partial withdrawal facilities after the lock-in period, which is generally five years.
• Tax benefits: Premiums paid qualify for tax deductions under Section 80C, and maturity proceeds are tax-exempt under Section 10(10D).

Traditional life insurance plans focus on life protection and financial stability. These are suitable for risk-averse individuals seeking guaranteed returns.

Key features:

• Guaranteed returns: Traditional plans offer fixed maturity benefits or bonuses, irrespective of market performance.
• Low-risk investment: These plans are ideal for individuals with low or no appetite for financial risk.
• Customised cover options: Options include endowment plans, whole life plans, and money-back plans, which cater to diverse financial needs.
• Loan facility: Some traditional plans allow you to borrow against the policy's cash value in times of financial need.

How much is the tax applied on the surrender value of ULIP?

The surrender value of a ULIP is the amount received by the policyholder if they decide to terminate the policy before its maturity. The tax treatment of the surrender value depends on the timing of the surrender:
 

• Surrender during lock-in period:

If the ULIP is surrendered within the five-year lock-in period, the entire surrender value is taxable as income in the year of surrender. The policyholder cannot claim any tax benefits under Section 80C for the premiums paid in the previous years.
 

• Surrender after lock-in period:

If the ULIP is surrendered after the completion of the five-year lock-in period, the tax treatment depends on the premium paid and the sum assured. If the premium paid does not exceed 10% of the sum assured, the surrender value is tax-free. If it exceeds 10%, the excess amount is taxable as income.

Investors should be cautious about surrendering their ULIPs within the lock-in period to avoid adverse tax implications.

ULIP tax-saving strategies

Implementing effective ULIP tax-saving strategies can help investors maximise benefits while staying compliant with tax laws. Here are key approaches to optimise tax savings with ULIPs.

• Choosing the right premium amount:

To ensure tax-free maturity proceeds under Section 10(10D), keep the annual premium within Rs. 2.5 lakh. Policies exceeding this limit are subject to capital gains tax on returns.

• Maximising Section 80C deductions:

Invest up to Rs. 1.5 lakh annually in ULIPs to claim deductions under Section 80C. Ensure the sum assured is at least ten times the annual premium to qualify for this benefit.

• Staying invested for the long term:

Holding a ULIP beyond five years not only avoids surrender charges but also enhances tax-free withdrawals. Partial withdrawals remain exempt if they follow the prescribed limits.

• Opting for equity-oriented ULIPs:

For long-term investors, equity-oriented ULIPs provide tax efficiency, as long-term capital gains (LTCG) tax applies only to gains above Rs. 1 lakh.

Both ULIPs and traditional plans have distinct attributes. Here is a side-by-side comparison:

• Assess your financial goals: If wealth creation is your priority, ULIPs might be ideal. For guaranteed financial security, opt for traditional plans.
• Consider your risk appetite: Risk-tolerant individuals can benefit from ULIPs. If you prefer stable, low-risk returns, traditional plans are a better choice.
• Review time horizon: For long-term wealth accumulation, ULIPs work well. If you need a guaranteed corpus for specific life stages, traditional plans are more suitable.
• Factor in costs: Understand the charges associated with ULIPs and weigh them against the benefits. Traditional plans generally have lower charges.