ULIPs in the spotlight after Finance Minister reintroduces Long Term Capital Gains (LTCG) tax on equity and equity-oriented mutual funds.
Mr. Aman, an avid equity investor, was eagerly sitting in front of his television set, waiting for the Budget 2018 speech. His colleagues had told him that the Finance Minister would reintroduce the LTCG tax. Mr. Aman was quite hopeful, this wouldn’t be the case, however, after a few minutes, it was confirmed that his colleagues were right.
In his Budget 2018 speech, Finance Minister Arun Jaitley re-introduced the Long-Term Capital Gains Tax, which was abolished by then Finance Minister P Chidambaram in 2004-05, and later replaced by a security transaction tax. During the announcement, it was said that LTCG tax would apply on equity and equity-oriented mutual, effective April 1, 2018. Under the new regime, capital gains arising from the sale or transfer of long-term capital assets will be taxed at 10% if the gains exceed the threshold of Rs. 1 lakh during the financial year. Another important point that was highlighted during the Budget Speech, which dampened Mr. Aman's mood further, was that investors would not get any indexation benefit while computing taxes. The indexation benefit would've significantly helped bring down the rate of tax, but it has not been made available to stock and equity fund investors.
To understand how LTCG tax is going to work, consider the case of Mr. Aman:
Imagine if Mr. Aman's capital gains on equities during the fiscal year 2018-19 totals Rs. 2 lakhs then as per the new regime, Mr. Aman will be taxed only on Rs. 1 lakh (Rs. 2 lakhs (profits) – Rs. 1 lakh (limit)). He will have to pay Rs. 10,000 (10% of Rs. 1 lakh) as LTCG tax on his profits. If his gains fall below the Rs. 1lakh mark, Mr. Aman will not have to incur this tax.
A few days later after the announcement, Mr. Aman's brother, Mr. Anil called him up to enquire about what's going on. When Mr. Aman told his brother about how the LTCG tax was going impact him, he also mentioned the grandfather clause.
"Huh", Mr. Anil reacted, “What has grandpa got to do with this?" he asked. That's when Mr. Aman told him that ‘grandfathering' clause is a special provision wherein an entity can be exempted from a new regulation. In the roll out of LTCG tax, all of the existing capital gains until January 31, 2018, are grandfathered. This means all the gains made up to January 31, 2018, is exempted from the 10% tax.
“Oh!” Mr. Anil responded.
LTCG Tax: Balance Tips In Favour Of ULIPs?
Next day, Mr. Anil rang up Mr. Aman and suggested that he consider investing in ULIPs. “Would that be a good option?” Mr. Aman asked. Well, let's see…
The imposition of LTCG tax on equity trading has led many investors to look for other investment avenues that fetch them higher returns with very little or no tax liabilities. ULIPs are a relatively better alternative, fulfilling medium to long term investment objectives with no such tax levied on the long-term capital gains.
What are ULIPs?
Unit Linked Insurance Plans offer the dual benefit of life insurance and investment. Investors can choose to invest their money in debt funds, equity funds or a mix of both, depending on their risk appetite and financial goals. Although investments in ULIPs are similar to mutual funds, the investor, however, will not have to bear LTCG tax on ULIPs.
But should an investor like Mr. Aman choose a ULIP solely because he does not have to incur LTCG tax? An informed decision calls for the comparison of other parameters too before investing in any product. Here is a quick peek at both the investment options, which can help you and others who find themselves in a similar situation as Mr. Aman decide where to park funds:
Yes, LTCG tax will not apply to ULIPs. But did you know, there are many more tax benefits that ULIPs can fetch you? Since ULIPs are predominantly an insurance tool, the maturity benefit, death benefit and partial withdrawals are not taxed. The proceeds paid by the insurance company, be it on maturity or the demise of the insured individual, will be tax free in the hands of the receiver under Section 10(10D) of the Income Tax Act, 1961. Investors can also claim tax deductions up to Rs. 1.5 lakhs on the premiums paid under Section 80C of the Income Tax Act, 1961. The only condition an investor needs to keep in mind is that the premiums should be less than 10% of the sum assured.
Profits reaped of more than Rs. 1 lakh through equity mutual funds, held for more than a year, attract 10% tax. If the investor holds it for less than a year, he or she will have to bear a 15% tax under the short-term capital gains.
Since ULIPs are an insurance product, they carry less risk compared to mutual funds. Equity-oriented mutual funds are especially riskier in nature compared to hybrid mutual funds, and hybrid funds carry more risk than debt funds.
ULIPs give investors the flexibility of moving between funds through its switch facility. When the market is not performing well, investors can switch to another fund to optimize returns. If, for instance, a dip in the stock market is expected, an investor can switch a large portion of his or her investment to debt or liquid funds, and later switch back when the market picks up. Mutual fund investors can only make a switch when they completely withdraw funds from one scheme to another, within the same fund house.
A mutual fund investor may have to bear an exit fee, in addition to the charges for the management of funds. A ULIP investor will have to incur charges associated with managing the fund, along with the administration charges and insurance premium. The fund management charges of ULIPs are less than mutual funds - 1.35% and 2.5%, respectively. The regulatory body IRDAI has mandated that the overall effective charges on ULIPs should not go over 2.25%.
Considering all the points mentioned above, Mr. Aman now thinks it would be a good idea to invest in ULIPs, since it will balance his portfolio out very well.
The introduction of LTCG tax on equities, has led more and more people like Mr. Aman to view ULIPs as a better choice of investment – in terms of tax savings and wealth creation. ULIPs encourage long-term savings since the lock-in period mandated by the IRDAI is five years. A combination product like ULIP offers investors the simplest way to enjoy three benefits in one plan - life cover, high returns and tax savings - with minimal risk.