Why ULIPs are one of the best tax saving instruments
Saving money aside, smart tax planning is an integral part of sensible financial planning. The average investor enjoys numerous tax-saving options like PFs and PPFs, life insurance plans, ELSS investments, ULIPs and more. When comparing different instruments, it is always advisable to choose an option that offers the combined benefits of wealth protection, value appreciation, strategic flexibility, and tax savings.
A traditional insurance plan offers life protection and tax benefits with very little scope for wealth creation. Mutual funds, on the other hand, offer good returns with zero life protection and restricted tax-saving opportunities. Conservative tax savings options like PFs are unlikely to generate inflation-proof real returns over the long run. ULIPs are a useful financial tool that can be used to bridge the gap between the various investment options along with the added advantage of significant tax savings.
A ULIP is an insurance plan where the premium paid is invested in equity, debt, or money market instruments. Subject to certain conditions, the premium paid towards this policy is allowed as a deduction u/s 80C of the Income Tax Act. So, ULIP premiums can be deducted from your taxable income up to the permissible limit u/s 80C, which is currently at Rs. 1.5 lacs.
The only condition is that the premium amount should be less than 10% of the sum assured under the ULIP. So, if the sum assured is Rs. 15 lacs and the premium paid is less than Rs. 1.5 lacs, then the entire amount can be claimed as deduction u/s 80C. If the premium is more than 10%, say Rs. 2 lacs for sum assured of Rs. 15 lacs, then the deduction amount is capped at 10% i.e. Rs. 1.5 lacs.
Further, a ULIP allows the policy holder to choose his or her preferred asset class. A young individual with high risk tolerance can opt for a high-risk high-return strategy of investing primarily in equities. Or, one can opt for a combination of equity, debt, and money market investments to enjoy high returns with minimal risks. Freedom to switch asset classes
A ULIP investor can also switch from one asset class to another or modify the proportion in which funds are invested in equity, debt, and money market instruments. This allows the investor to benefit from market upturns and escape market downturns, to ensure the greatest chance of steady wealth appreciation. A mutual fund, on the other hand, has a pre-determined allocation strategy that cannot be modified, which can limit flexibility.
For instance, an individual choosing a low-risk mutual fund strategy will have to continue with a conservative approach even if the economy booms. If one invests in a high-risk equity mutual fund at a time when the economy shows signs of a prolonged slump, then one can either hope for the best or liquidate the units at a loss.
In the case of a ULIP, however, one can modify their investment strategy and switch to a greater allocation of low-risk debt investments without any hassles. Conversely, a conservative strategy can be altered for greater equity allocations and reduced debt or money market investments to take advantage of a boom in the equity markets.
Along with the above-mentioned benefits, ULIPs also offer fantastic tax savings on withdrawals that are unavailable to mutual fund investors. Withdrawals may occur in the following instances:
a. Death of the policy holder b. Maturity of the policy c. Partial withdrawal at the discretion of the policy holder
Death benefit paid under the ULIP is completely tax free. In this respect, the ULIP resembles a traditional life plan offering assured financial protection to the family of the insured. Of course, the payout can be higher than the sum assured depending on the returns generated by the unit-linked investments.
Upon maturity of the ULIP, the policy holder will receive the assured benefit or the value of the unit-linked investments whichever is higher. This payout is exempt u/s 10(10D) of the Income Tax Act. This is a significant difference between ULIPs and mutual funds as the income earned from the latter is fully taxable.
ULIPs have a minimum lock-in period of five years. The policy holder is permitted to make partial withdrawals after this period. The partial withdrawals, which cannot exceed 20% of the fund value of the policy, are completely tax free, provided they are made after the completion of the lock-in period.
This feature allows individuals to use ULIPs for goal-centric planning. You can use ULIP investments to plan for significant milestones like marriage, home purchase, education or marriage of your children. Versatile investment options allow you to mitigate the negative impact of inflation and benefit from the economic development of the country. Combining equity with debt will allow you to manage your risk profile depending on your age, current income, and other factors.
Top-up your investments
Finally, ULIPs allow individuals to invest excess cash through periodic top-ups. The top-ups may be eligible for deduction u/s 80C as well as exemption u/s 10 (10D) provided the condition of the premium not exceeding 10% of the sum assured is not violated. In any case, the additional returns generated through top-up investments will ensure the potential tax liability does not affect your financial planning.
In an ideal situation, separate investments in life insurance and mutual funds would help the individual enjoy good returns, assured protection, and attractive tax savings. Unfortunately, striking the right balance between multiple investment products can be a very difficult task.
This is why investing in a combination product like ULIP is the simplest and most elegant way to enjoy the triple benefits of life cover, high returns, and tax savings with minimal risk of losses or other complications.