India recently introduced a new life insurance tax regime that will have a significant impact on policyholders, particularly those with high premium policies. Under the new regime, any amount from a life insurance policy with an annual premium over INR 500,000 is taxable. This includes the sum insured, any premiums and other benefits. The new tax regime is likely to make traditional insurance plans less attractive to investors. These plans are typically purchased by risk-averse investors looking for a guaranteed return on their investment. However, with the new tax regime, income from these plans will be taxed, which could make them less attractive.

Recently, the Central Board of Direct Taxes (CBDT) issued updated guidelines on the calculation of life insurance income with premiums in excess of INR 500,000. This new tax rule has significant implications for policyholders, particularly those with high-premium policies. Under this new regime, any life insurance proceeds with an annual premium of more than INR 500,000 will be subject to taxation. As a result, Section 10(10) of the Income Tax Act, which previously provided exceptions, no longer applies to policies with premiums in excess of this threshold. This revised life insurance tax regime will come into effect from fiscal year (FY) 2023-24.

Find business support

In addition, in more than one policy situations, the same rule applies if the total annual premiums of all policies within a financial year exceed INR 500,000. Consequently, the aggregate maturity amount of all combined policies would be subject to taxation.

Under the previous framework, Section 10(10) of the Income Tax Act extended the exemptions to certain life insurance amounts, including bonuses. However, these exceptions will be rendered obsolete by the newly formulated CBDT guidelines.

Important exceptions communicated in the modified tax rule

Two important exemptions have been identified in the revised tax framework:

• death of the policyholder: In the event of the death of the policyholder, a tax exemption is granted on proceeds.
• Unit Linked Insurance Plans (ULIPs): ULIPs are not subject to the revised tax rules and retain their exempt status.

Impact of the new regulation on traditional insurance plans

Experts say these changes could potentially negatively impact traditional insurance plans such as endowment, cash-back and retirement plans. The new tax framework could make these plans, which are usually favored by risk-averse investors, less desirable.

Benefits of investing in ULIPs

A unit-linked insurance plan (ULIP) is a financial product that provides a combination of investment and life insurance coverage. It enables individuals to achieve long-term financial goals while providing life insurance for their families in the event of unfortunate events. The premium paid for a ULIP is split into two parts: one part goes towards life insurance and the other part is invested in a fund of the individual’s choice which may include equity, debt or a mix of both depending on risk tolerance and objectives .

related reading

The amount that can be invested in a ULIP depends on a number of variables, including the length of the contract, the amount insured and the age of the policyholder. If the total premium paid for all ULIPs in a financial year exceeds INR 250,000, the maturity proceeds from the ULIP will be taxed.

With the introduction of this new regime, ULIPs have become a more attractive investment option for taxpayers. Investing in a ULIP allows individuals to customize their life insurance and investment strategy to suit their specific needs. It offers the flexibility to adapt to changing financial situations and goals while taking advantage of potential tax benefits.

Here are the benefits of investing in ULIPs:

• Customizable Life Insurance: ULIPs offer the flexibility to choose the level of life insurance coverage you want. While minimum life insurance is typically 10 times the annual premium, depending on the policy and insurance company, individuals may opt for higher coverage, potentially up to 40 times the annual premium or even more.
• Investment choice: ULIPs offer a range of fund options, including equity funds, debt funds, and mixed funds that combine both equity and debt investments. Investors can tailor their investment strategy to their financial goals and risk appetite. For example, those seeking capital appreciation and accepting greater risk can invest in equity funds, while those looking for stable returns can invest in debt funds.
• Liquidity and partial withdrawal: ULIPs offer a partial withdrawal option, allowing policyholders to withdraw some of their invested money when needed. This feature is useful for covering immediate expenses such as education fees or emergencies. In principle, there are no fees for partial withdrawals.
• Target-oriented planning: ULIPs are designed to help achieve specific financial goals, such as: B. the creation of wealth, old-age provision or the financing of education. Investing in ULIPs allows individuals to work toward securing their long-term goals while knowing that their rewards are contributing to those goals.
• Tax Benefits: ULIPs provide tax benefits under the Income Tax Act 1961 and allow for tax savings at various stages of the policy:
  • Entry Advantage: Premium payments are eligible for tax benefits under Section 80C of the Income Tax Act.
  • Exclusive switching benefit: Switching between debt and equity funds within the ULIP is tax-free.
  • Exit Advantage: Benefits when due are tax exempt, subject to the conditions set out in Section 10(10D) of the Income Taxes Act.