Investment in ULIP – An option to save LTCG Tax

Taxes don’t die. Union Budget 2018 has proposed to re-introduce LTCG tax on shares & equity oriented mutual funds.

Saving tax is one of the fundamental rights with the taxpayer. Investment is one of the most powerful tools in the hands of the taxpayer to reduce impact of tax. One such choice in the hands of the taxpayer so far was investment in shares & Equity oriented mutual fund (EOMF) which was offering tax free return. However, all EOMF & ELSS will now be subject to tax.

Investors are now exploring the new option to curtail the tax bill. Unit Linked Insurance Product (ULIP) is well equipped to avoid a rigor of new LTCG tax. Though taxation is one of the key parameters for making any investment decision but this is not the only consideration.

Let us know the other factors that are equally relevant for determining the investment:

1. ULIP has almost same benefit & feature as is offered by mutual funds.  Also ULIP, like mutual fund, invests the amount in equity / debt funds. ULIP is a combination of a life insurance cover & mutual fund.

2. Investment in debt option in a ULIP even today is tax free whereas it is taxable in case of MF. The short-term capital gain of debt oriented mutual fund is taxable as per the Income tax slabs in case of Short Term Capital Gain (STCG) whereas it is taxed at 20% after indexation in case of Long Term Capital Gain (LTCG).

3. ULIP has a special tax treatment. Under section 10 (10D) of the income-tax Act, if the sum assured in a life insurance policy is at least 10 times the annual premium, then proceeds from the policy (whether at the time of maturity or surrender after 5 years) are completely tax free.

4. Both, mutual funds as well as ULIP levy a fund Management Charge for its maintenance which keep varying. Mutual fund don’t provide for life insurance cover whereas ULIP provides for life cover. Since, life cover is inbuilt in ULIP, it deducts mortality charges from the amount invested. As a result, fund invested is reduced to that extent.

5. There is no lock in period in the case of Mutual Fund in general. However, tax saving mutual fund (i.e., Equity Linked Saving Scheme-ELSS) carry a lock in period of 3 years. For ULIP, higher lock in period of 5 years is there.

6. With the proposal to tax LTCG, mutual fund would be entirely in the tax net. ULIP will continue to enjoy the tax exemption as mentioned above. Higher the returns from share market, higher would be effect of tax saving from ULIP in comparison to Mutual fund.

7. ULIP is a multi-year commitment. The buyer has to keep paying the premium for the full term of the plan. There is no such constraint in case of mutual fund where option to invest or not carry enough flexibility.

8. The switching facility is now aptly incorporated by the insurance companies in ULIP product. As a result, investor can switch from equity to debt and vice-versa without incurring a tax liability. In mutual funds, such switch over attracts tax implications. The best part is that switches between the different funds within a ULIP are tax-free whereas it is not so in case there is switch from one scheme to another scheme. In case of mutual fund, such redemption or switches attracts tax.

9. Though ULIP charges are higher, it is the cost of the life insurance cover provided to the investor. “No tax label” has a cost attached to it in the form of mortality charges (i.e., insurance cost). However, charges levied in ULIP are well rationalize over a period of time, making it equally efficient.

Now coming back to the original question, whether to invest in ULIP or mutual fund? Combo of mutual funds & term insurance was considered as one of the best option for investment so far. However, with the reintroduction of LTCG tax, taxpayers should combine “Insurance with Investing”.

Considering the direct tax impact, ULIP may be considered as better investment in comparison to ELSS & Mutual fund as ULIP returns are still tax-free. To be more calculative, till mortality & other charges are less than 10.40% (i.e., effective rate of LTCG tax) of anticipated income from ULIP, it would be advisable to prefer ULIP over Mutual Fund.

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