The countdown to save tax for the current financial year (FY) 2018-19 has begun. Ajit, in his mid-20s, has received a second reminder from the accounts department to submit proofs for investment declarations he had made earlier in the FY. In the absence, Ajit would see a higher TDS (tax deduction at source) in the last few months of the year, resulting in lower take-home pay.
Ajit turned to a senior colleague in his office, who advised him to invest in a unit linked insurance plan (ULIP) as it would not only help create tax savings, but also help him save for long term financial goals.
Do millennials favour ULIPs?
As most millennials do, Ajit wanted to explore ULIPs before making an investment decision. Digging deeper, he discovered that it is an investment product with built-in insurance. What he liked the most was that it is a market-linked investment, thus letting him take advantage of equities in the long term. The ULIP also allowed him to invest in other asset classes and across different sectors and market capitalisation. As a product that required premiums to be paid regularly, it would also help him remain focused on long-term saving.
He discovered that to derive optimum benefits from ULIP, linking it to long term goals such as the down payment for a home loan, children’s education, marriage or retirement makes perfect sense. This not only instils financial discipline but also deters decision-making based on short-term market movements.
What makes ULIP a tax-friendly investment
Ajit also learnt that ULIPs come with tax provisions that could help create a tax-efficient corpus over the long term. Under current tax laws, ULIPs come with EEE(exempt-exempt-exempt) benefit. The first E signifies that any premium invested gets tax exemption ( deductible from gross income) at the investment stage, the second E denotes that any growth ( during policy period) remains tax exempted and the last E represents that maturity proceeds are also tax-free. However, to meet EEE status, all insurance policies including ULIPs, need to meet certain conditions. Any investment in ULIP, up to Rs 1.5 lakh per financial year (FY), qualifies for tax benefit under the Section 80C of the Income Tax Act 1961, as long as the premium paid in any FY does not exceed 10 percent of the sum assured. If this condition is met, the gross total income decreases by an amount equal to one’s investment in ULIP, reducing tax liability. Section 10(10D) makes income on maturity tax-free as long as the premium here is also not more than 10% of the sum assured or the sum assured. Income Tax rules also permit death proceeds in the hands of the nominee to be tax-free. ULIP also allows partial withdrawals any time after five years of the policy, which helps meet any medium-term goals. As per current tax laws, they are tax-free in the year of withdrawal.
How to make ULIPs work to your advantage
Although one should allocate funds across different options – equity and debt, youngsters with aggressive risk profiles may consider investing more in equity funds in the initial years of the policy. Closer to maturity, funds can be switched into debt funds through de-risking. De-risking is the process of moving funds from equity assets to less volatile debt funds over time. With age, both Ajit ‘s income and financial liabilities will rise. ULIPs allow for the investment of additional funds in the same policy through top-ups. This helps keep the investment directed towards long-term savings.
ULIPs serve the twin objective of saving taxes and using savings to meet long term financial goals. The flexible nature of ULIP and its transparent structure makes it an apt investment for long term goals provided it is bought in the right way.