How Capital Gains Are Calculated in ULIP Plan?

You just received your monthly income and have set aside an amount to put in a scheme. But you can’t decide whether to buy units in an investment scheme to grow your money or to put your money in an insurance scheme to secure your family’s future. The solution to your problem is a product called a unit-linked insurance plan (ULIP). A unit here refers to a unit in a Mutual Fund S.I.P. as the product combines the benefits of both mutual fund investments and insurance schemes. However, the focus of today’s article is how the tax levied on the gains earned on a ULIP is calculated. Now, why do you need to know the calculation of gains tax? What are the types of gains tax? And what is the amount of tax you pay on them? Read the following article to find out.

All About Unit-Linked Investment Plans

As mentioned earlier, a unit-linked investment plan combines an insurance scheme with a mutual fund S.I.P. An insurance premium is paid by the policyholder, out of which a certain portion is used to systematically invest in a mutual fund S.I.P., while the rest is used to form the pool out of which the insurance claims are paid out as and when required. The gains that are made on such S.I.P.s can be distributed to the policyholders as dividends, reinvested into the scheme, or accumulated within the ULIP, leading to an increase in the ULIP’s overall value.

Key Features Of A Unit-Linked Investment Plan

1. Returns through investment schemes:
   Since the money paid to the investment scheme as a premium is not sitting idle but is invested in mutual fund S.I.P.s, it brings in returns that can be used to either pay out as dividends, reinvested into the investment scheme to grow the investment fund corpus, or accumulated within the ULIP, increasing its overall value.

2. Insurance Coverage:
   A part of the premium being invested into an investment scheme does not compromise the beneficiary’s payout. Rather, in the case of the demise of the policyholder, the nominee is given full insurance coverage. So, you can invest in a ULIP without worrying about the financial protection of your loved ones.

3. Lock-In Period:
   ULIPs usually have a lock-in period of 3 to 5 years, meaning that you can’t submit the policy and withdraw the money before this period is over.

4. Eligibility For Tax Benefits:
   ULIPs are also eligible for tax benefits under Section 80C of the Indian Income Tax Act, 1961, wherein investments up to ₹1.5 lakh are eligible for tax deductions, while under Section 10 (10D), maturity benefits or sum assured received from a life insurance policy in case of death or severe illnesses of a policyholder are eligible for tax exemptions.

ULIP Capital Gains Tax

The gains you earn whenever you sell equity-linked mutual fund assets in a ULIP scheme are taxable. These gains are categorised into either long-term capital gains or short-term capital gains.

The difference is simple: Gains earned on selling the assets you held for less than a year are called short-term capital gains. If you hold assets for more than a year, the gains earned on selling those will be referred to as long-term capital gains. The taxes levied on short-term capital gains are called short-term capital gains tax (S.T.C.G.), and the ones that you pay on the long-term capital gains you earn are the long-term capital gains tax (L.T.C.G.).

Some Key Features Of ULIP Capital Gains Tax

• As mentioned before, no tax is levied on the insurance coverage paid out to the beneficiary in case the policyholder dies. Taxes are only paid on the capital gains.

• In case the yearly premium for the ULIP is less than ₹2.5 lakh, you are not liable to pay long-term capital gains tax on the gains that you earn.

• In a similar rule, if the capital gains earned on the ULIP assets do not exceed ₹1.25 lakhs, long-term capital gains tax is not levied on these gains.

How Are ULIP Capital Gains Tax Calculated?

As we have already mentioned, capital gains earned on selling off your ULIP assets can be categorised based on the holding period of those assets. Similarly, taxes are decided based on whether the taxable capital gains are short-term or long-term. Let’s have a look:

Short-Term Capital Gains Tax (S.T.C.G.)

Any gains that are earned after holding the assets for less than a year are directly to your taxable income. They are hence taxed as your income for the financial year depending on whichever slab you fall into based on your income.

Long-Term Capital Gains Tax (L.T.C.G.)

As we have already mentioned, the long-term capital gains earned on ULIP assets need to be at least ₹1.25 lakhs in order to be taxable. In case the long-term gains do exceed ₹1.25 lakhs, only the amount exceeding the limit would be taxable. So, if the long-term capital gains earned are ₹1.5 lakhs, only ₹25,000 would be taxed. This calculation is subject to indexation benefits as well. Since the Union Budget 2024, the tax rate has been revised to 12.5%. This means that in the case we just mentioned, the tax liability would be 12.5% of ₹25,000, i.e., ₹3,125.

Let’s understand with the help of an example: Suppose you had acquired ULIP assets for ₹10,00,000 back in April 2021 and had sold them off in July this year for a price of ₹16,00,000. In doing so, you have made a capital gain of ₹6,00,000. Hence, a 12.5% tax would be levied on the amount of ₹4,75,000. Assuming the rate of inflation for this period was 5%, you can claim indexation benefits, after which your cost of acquisition would become ₹11,57,625. Hence, the tax you would pay would not be on a capital gain of ₹6,00,000. Rather, the new long-term capital gain would be ₹4,42,375. Hence, the tax paid would be 12.5% of ₹3,17,375.

Conclusion

Hence, it can be understood that capital gains on ULIPs are taxable based on the holding period of the ULIP assets. It was also mentioned that investments of up to ₹1.5 lakh per financial year are tax-exempt under Section 80C of the Indian Income Tax Act, 1961, while maturity benefits or sum assured received from a life insurance policy in case of death or severe illnesses of a policyholder are eligible for tax exemptions under Section 10 (10D) of the same act. Similarly, long-term capital gains taxes are not levied in case the yearly premium paid to the ULIP plan is less than ₹2.5 lakh and/or the long-term capital gains earned are less than ₹1.25 lakh. All of this is a very crucial piece of information and, if understood and applied properly, could lead to better tax savings along with the benefits of your own financial security and of your loved ones through investing and insurance.

Frequently Asked Questions

Q1. Was the tax rate on LTCG not 10%?
Ans. It was, but the tax rate was revised after the Union Budget, 2024.

Q2. What is the indexation benefit?
Ans. Indexation benefit is simply finding out the present value of the money you paid to acquire the asset you sold. For example, if I acquired an asset for ₹5 lakh 10 years ago, that ₹5 lakh would be worth much more in today’s economy due to inflation. Hence, the indexation benefit finds the present value of your past acquisition cost so that the capital gain calculated is less than the one calculated without indexation, saving tax in the process.

Q3. How do we know what the inflation rate is if we want to calculate the present value of acquisition cost for indexation benefit?

Ans - This can be determined using the Cost Inflation Index (CII) notified by the government of India annually, usually in January of the following year, and can be found on the website of the Indian Income Tax Department or other government websites. The Cost Inflation Index (CII) is a measure of the average change in prices of goods and services consumed by urban non-manual employees in India.