Income Tax Benefits – Implication On ULIP Investors

Holders of unit-linked policies (ULIPs) might have to see tough days ahead. If the much-hyped row between IRDA and SEBI was not enough, the revised direct tax code could hit the investors hard which is to be out in a month or two. The draft Direct Tax Code submitted last August proposed a tax on returns for insurance policies where the premium paid is less than 20 times the sum assured. A final version is expected in the next couple of months which will lay down the details on the issue.

Nearly all ULIPs have a premium to sum assured ratio of 1:5. All such policies under the direct tax code are expected to be taxed at the time of maturity or withdrawal. There isn’t much worry about traditional policies since most of them adhere to the 1:20 criteria.

For instance, if the sum assured for a ULIP is less than 20-times the premium paid for such policies, one may have to pay taxes on the returns from April 2011 onwards. Currently it is exempted but it could change once the revised direct tax guidelines come. ULIP holders will need to modify their plans accordingly to ease the tax burden. However, returns on ULIPs may decline if one has to adjust it to make it tax exempt by increasing the sum assured value. More sum assured means an increased portion of premium going into paying mortality charges which will leave less money to be invested into units — the portion of the money that goes into either equity or debt to earn returns i.e.  in case a policy holder opts for increasing the insurance component, a greater portion of his total premium paid will now go into paying mortality charges — the pure insurance component of a unit-linked policy. This means, less money will get invested into the units — be it bond or equity as per the scheme’s.

The direct tax code will replace the Income Tax Act, and will be available for comments soon before it is finalized and is expected to be placed before Parliament for its approval in the winter session.
The initial draft of the DTC was submitted in August last year. There were some issues with the industry and it went for redrafting. According to senior officials from the Central Board for Direct Taxes, all these industry issues have been taken care of in the revised draft.