ULIP Invested - Taxes When Switching After Daughter's Relocation?

Ans: You have invested Rs 15 lakh over 5 years in a ULIP (Unit Linked Insurance Plan). The fund value has grown to Rs 31 lakh, which is a good return. Your intention was to save for your daughter's education, but now the situation has changed as you're living in Canada. You don’t require the funds immediately, and your daughter may not study in India. Let’s evaluate the best approach to managing this investment and how to minimize taxes on withdrawal.

It’s worth noting that ULIPs are a mix of investment and insurance. Your policy term is 20 years, and it’s crucial to decide when and how to withdraw the funds based on your financial goals and tax efficiency.

Withdrawal Timing and Strategy
Long-Term Growth Potential: Since the policy has a 20-year term, you have the flexibility to stay invested for more time. ULIPs tend to show better growth after the 10-year mark. If you are not in urgent need of funds, you could let the investment grow further.

Taxation on ULIPs: ULIPs have a tax benefit if the annual premium is less than Rs 2.5 lakh per year. Given that your investment was Rs 3 lakh per year, this might not apply to you. However, if the policy's sum assured is at least 10 times the annual premium, the maturity proceeds may still be exempt from tax under Section 10(10D).

Partial Withdrawals: ULIPs allow partial withdrawals after the lock-in period (which is typically 5 years). These withdrawals are tax-free up to a certain limit. This can help you gradually access your funds while spreading out the tax impact.

Exit Strategy: If you choose to exit the ULIP entirely, the proceeds will be subject to capital gains tax, depending on your policy’s sum assured and premium structure. Given that you're now a Canadian resident, taxation in Canada may also come into play. Consulting with a tax expert familiar with cross-border tax implications can help here.

Taxation for Indian Residents
Tax on ULIP Withdrawals: If your premium exceeds Rs 2.5 lakh in a year, the returns from ULIP are taxable. The capital gains tax on equity-oriented funds (which most ULIPs are) is 12.5% for long-term capital gains exceeding Rs 1.25 lakh. The gains you have earned might fall under this category.

Tax-Free Insurance: If the sum assured in your ULIP is 10 times or more than the annual premium, then the maturity proceeds can be tax-free under Section 10(10D). Check your policy to see if you meet this condition.

Lock-in Period: Since ULIPs have a 5-year lock-in, you’ve already crossed that threshold. There is no additional lock-in after this period, so you can make withdrawals anytime without penalties.

Impact of Canadian Residency on Taxation
Double Taxation: As a Canadian resident, you may be taxed on your worldwide income. Withdrawals from your ULIP in India might also be subject to Canadian taxes. To avoid double taxation, explore the tax treaty between India and Canada, which might offer relief. Speaking with a tax consultant familiar with both tax systems can be beneficial.

Timing of Withdrawals: Given the tax implications in both countries, it may be better to stagger withdrawals over several years. This can reduce the tax burden by spreading the gains across different financial years.

Fund Growth and Diversification
ULIP Fund Performance: The current value of Rs 31 lakh is a good indication that your ULIP has performed well. However, ULIPs typically come with higher charges compared to mutual funds. Over the next few years, the charges could eat into the returns, especially if the policy has high mortality charges.

Market Conditions: The market has been volatile recently, but equity-based ULIPs tend to perform well over the long term. You could consider switching your fund allocation within the ULIP to a more conservative fund (like a debt fund) if you prefer a safer approach now.

Switching Funds: ULIPs offer fund-switching options, allowing you to change the allocation between equity and debt funds. This flexibility can help you manage risk, especially as you near the point of withdrawal.

Should You Stay Invested or Exit?
Cost of Staying Invested: ULIPs have various charges, including fund management charges, policy administration fees, and mortality charges. As you progress further into the policy term, these charges may increase, especially if your insurance cover is high. Assess if the growth of the fund outweighs these costs.

Insurance Needs: If the insurance component of your ULIP is no longer relevant (since you are now living in Canada), you may consider surrendering the policy. ULIPs are not the most cost-effective way to get life insurance, and term insurance might be a better option if insurance is still a priority for you.

Surrendering the ULIP: If you decide that the charges and complexity of the ULIP outweigh the benefits, you can surrender the policy. The surrender proceeds will be taxable if your premiums exceed Rs 2.5 lakh annually, and if the sum assured is not at least 10 times the premium. The proceeds will be treated as long-term capital gains and taxed accordingly.

Modes of Withdrawal
Partial Withdrawals: As mentioned, partial withdrawals from ULIPs are tax-free up to a certain limit. You can withdraw part of your investment every year, reducing the overall tax impact. This also allows the remaining funds to grow.

Full Withdrawal: If you need the full amount, consider withdrawing in a year when your income is lower, which may reduce the tax liability.

Switch to Debt Fund: If you are looking for more stable growth, you can switch your ULIP allocation to debt funds. This reduces the volatility and risk, especially as you get closer to the time you may need the money.

Investment Alternatives for Future
Regular Mutual Funds: For future investments, consider regular mutual funds through a Certified Financial Planner. These offer more transparency, flexibility, and generally lower costs compared to ULIPs. Mutual funds also offer a wide range of options across different risk profiles.

Actively Managed Funds: While index funds are often popular, actively managed funds tend to outperform in specific markets. A Certified Financial Planner can help you select funds that suit your risk profile and long-term goals.

Child Education Planning: Since your daughter may study abroad, look into international education savings plans. This can help you invest in a way that aligns with future educational expenses in countries like Canada.

Finally
Your decision on when to withdraw from your ULIP depends on multiple factors: tax efficiency, fund performance, and your financial goals. As a Canadian resident, you must also consider the tax implications in both countries.

If you do not need the funds right now, staying invested for the long term could be beneficial. However, keep an eye on the charges and switch to a conservative fund if you prefer to reduce risk.

Exploring alternatives like mutual funds for future investments could be a more cost-effective strategy, especially with professional guidance. Your daughter’s education is a critical goal, and investing with that in mind is key.

Best Regards,

K. Ramalingam, MBA, CFP,
Chief Financial Planner,
www.holisticinvestment.in
https://www.youtube.com/@HolisticInvestment