ULIP Taxation

Key rules for ULIP maturity benefits:

1. Maturity payout:

When a ULIP policy matures, the policyholder receives the fund value, which is the total value of your investment units, based on the prevailing NAV (Net Asset Value) of your chosen funds. The fund value is influenced by the performance of equity, debt, or hybrid funds selected by the policyholder at the time of purchase or through switches during the policy term.

2. Lock-in period:

ULIPs come with a mandatory lock-in period of 5 years. During this period, partial withdrawals or policy surrenders are generally not permitted, except under exceptional circumstances. Only after the lock-in period can the fund be accessed, either through partial withdrawals or upon maturity.

3. Tax treatment on maturity:

One of the major attractions of ULIPs is the ULIP maturity tax exemption under Section 10(10D) of the Income Tax Act. This means the amount you receive at maturity is tax-free, provided:

• The annual premium is less than 10% of the sum assured (for policies issued after April 1, 2012),
• The policy is held for at least five years.

However, if the premium exceeds the 10% threshold, ULIP tax rules change — the maturity proceeds may become taxable under capital gains provisions.

4. Partial withdrawals:

After the lock-in period, ULIPs allow partial withdrawals, which can be useful for emergencies or financial goals. However, frequent or large withdrawals can reduce the eventual maturity amount.

5. Switching between funds:

ULIPs offer fund switching options — allowing policyholders to shift between equity, debt, and balanced funds depending on market outlook and risk appetite. These switches are typically tax-free and can be done several times within a year depending on the plan. Smart fund switching can enhance your final maturity corpus.

ULIP taxation limitations every investor should know

Unit Linked Insurance Plans (ULIPs) have long been popular for offering the dual benefit of insurance and investment, along with tax advantages. However, with recent amendments in tax regulations, the landscape of ULIP tax treatment has changed, especially for high-value policies. Understanding the ULIP taxation limitations ensures that you don’t overlook potential tax liabilities or assume exemptions that may no longer apply. If you're aiming for long-term wealth creation, it's important to be aware of the boundaries that affect your tax benefits and net returns. Here are some of the major limitations associated with ULIP taxation:
 

Key ULIP taxation limitations:

• Premium cap for exemption: If the annual premium for ULIPs issued after 1 Feb 2021 exceeds Rs. 2.5 lakh, maturity proceeds are not exempt under Section 10(10D).
• Capital gains tax: If the Rs. 2.5 lakh premium limit is breached, gains on maturity are taxed as capital gains similar to equity mutual funds.
• No indexation benefit: ULIP capital gains do not enjoy indexation benefits, reducing the tax-efficiency for long-term holdings.
• Multiple policies rule: The Rs. 2.5 lakh limit applies cumulatively across all ULIPs owned by the policyholder.
• No exemption on discontinued ULIPs: Tax benefits are forfeited if the policy is surrendered before the 5-year lock-in period.
• Taxable partial withdrawals: In high-value ULIPs, partial withdrawals may be taxed, depending on the structure and timing.

Understanding these ULIP tax rules helps avoid surprises and align your investment strategy with actual post-tax returns.

How much is the tax applied on the surrender value of ULIP?

The surrender value of a ULIP is the amount received by the policyholder if they decide to terminate the policy before its maturity. The tax treatment of the surrender value depends on the timing of the surrender:
 

• Surrender during lock-in period:

If the ULIP is surrendered within the five-year lock-in period, the entire surrender value is taxable as income in the year of surrender. The policyholder cannot claim any tax benefits under Section 80C for the premiums paid in the previous years.
 

• Surrender after lock-in period:

If the ULIP is surrendered after the completion of the five-year lock-in period, the tax treatment depends on the premium paid and the sum assured. If the premium paid does not exceed 10% of the sum assured, the surrender value is tax-free. If it exceeds 10%, the excess amount is taxable as income.

Investors should be cautious about surrendering their ULIPs within the lock-in period to avoid adverse tax implications.

ULIP tax-saving strategies

Implementing effective ULIP tax-saving strategies can help investors maximise benefits while staying compliant with tax laws. Here are key approaches to optimise tax savings with ULIPs.

• Choosing the right premium amount:

To ensure tax-free maturity proceeds under Section 10(10D), keep the annual premium within Rs. 2.5 lakh. Policies exceeding this limit are subject to capital gains tax on returns.

• Maximising Section 80C deductions:

Invest up to Rs. 1.5 lakh annually in ULIPs to claim deductions under Section 80C. Ensure the sum assured is at least ten times the annual premium to qualify for this benefit.

• Staying invested for the long term:

Holding a ULIP beyond five years not only avoids surrender charges but also enhances tax-free withdrawals. Partial withdrawals remain exempt if they follow the prescribed limits.

• Opting for equity-oriented ULIPs:

For long-term investors, equity-oriented ULIPs provide tax efficiency, as long-term capital gains (LTCG) tax applies only to gains above Rs. 1 lakh.

• Tax exemption limit: Investors enjoyed a ULIP 2.5 lakh tax exemption under Section 80C, which allowed up to Rs. 2.5 lakh to be deducted from taxable income.
• Premium tax deduction: The amount you pay as premiums in ULIPs was eligible for ULIP tax deduction up to Rs. 1.5 lakh (combined with other 80C investments).
• Maturity proceeds: If your ULIP policy lasted for more than 5 years, the maturity proceeds were completely tax-free under Section 10(10D).
• Partial withdrawals: Withdrawals before 5 years attracted tax, but after 5 years, withdrawals were tax-exempt.
• Surrender value: If you surrendered your policy after 5 years, the proceeds were also tax-free.
• Capital gains treatment: Gains were not treated as capital gains but as income exempt from tax if the policy was held for 5+ years.

Before Budget 2025, ULIPs were pretty tax-friendly, encouraging long-term investments with clear benefits on both premiums and maturity returns.
 

ULIP taxation rules after budget 2025

Now, post-Budget 2025, things have changed quite a bit. Here’s what you need to know about the new ULIP tax rules:

• Abolishment of full tax exemption on maturity: Maturity proceeds exceeding Rs. 1 lakh will now be taxed as capital gains.
• Capital gains tax introduced: Gains from ULIPs are subject to capital gains tax at 10% without indexation benefits if held beyond 5 years.
• Premium tax deductions remain: You can still claim ULIP tax exemption on premiums up to Rs. 1.5 lakh under Section 80C.
• No change in surrender rules: Surrender proceeds are also subject to capital gains tax similar to maturity proceeds.
• Impact on long-term gains: This means ULIP returns post-5 years will now face taxation, reducing the overall tax benefits.
• Policy term remains crucial: Holding policies for 5 years or more is still beneficial but doesn’t fully exempt you from taxes.
• Effect on investor decisions: This might make investors reconsider ULIPs compared to other tax-saving instruments.

The Budget 2025 has reshaped the ULIP tax exemption landscape significantly, making it essential for investors to re-evaluate their portfolio strategies.

Wondering why these changes came into play? Here’s a quick look at the government’s reasoning behind the new ULIP tax rules:

• Revenue generation: The government aims to widen the tax base and increase revenue by taxing gains previously exempt.
• Level playing field: The change brings ULIPs closer in line with mutual funds and other investment vehicles, creating fair tax treatment.
• Discouraging tax avoidance: Previously, some investors used ULIPs primarily as tax shelters, which the government wanted to curb.
• Promoting transparency: Taxing gains makes ULIPs more transparent and aligns taxation with actual earnings.
• Encouraging informed investments: The changes nudge investors to evaluate the true returns after tax, encouraging more prudent decisions.
• Simplifying tax structure: Introducing capital gains tax on ULIPs simplifies the previously complex exemption rules.

These changes reflect a broader government effort to create a balanced and fair investment ecosystem while still offering some ULIP tax exemption benefits on premiums.

How much is the tax applied against long-term capital gains on ULIPs?
 

The tax treatment of long-term capital gains (LTCG) on ULIPs depends on the premium amount and the date of issuance of the policy:

ULIPs issued before 1st February 2021:

• For ULIPs issued before 1st February 2021, the LTCG on maturity proceeds is tax-free. This is true if the premium paid is not more than 10% of the sum assured.
• There is no tax liability on the returns earned from these ULIPs.

ULIPs issued after 1st February 2021:

• For ULIPs issued on or after 1st February 2021, the tax treatment is different.
• If the yearly premium of the ULIP taxation is more than Rs. 2.5 lakh, the maturity amount will be taxed as capital gains.
• The LTCG will be taxed at 10% if the gain exceeds Rs. 1 lakh in a financial year.
   

Tax-free limit:

ULIPs with an annual premium not exceeding Rs. 2.5 lakh continue to enjoy tax-free status on maturity, even if issued after 1st February 2021. This ensures that small investors can benefit from tax exemptions on their investment returns.

ULIP capital gains taxability on maturity

ULIP tax rules state that if the annual premium exceeds Rs. 2.5 lakh for policies issued after February 1, 2021, the maturity proceeds become taxable as capital gains. Otherwise, they remain tax exempted under Section 10(10D). For example, if policyholder’s ULIP premium is Rs. 3 lakh annually, the capital gains on maturity will be taxable under ULIP tax provisions.

Is any tax applied on the death cover on ULIP?

The death cover received by the nominee in the event of the policyholder's demise is completely tax-free. Under Section 10(10D) of the Income Tax Act, the entire death cover amount, including the sum assured and any additional returns, is exempt from tax. This ensures that the policyholder's family receives the full financial protection without any tax liability.

The tax exemption on the death cover makes ULIPs an attractive option for those looking to secure their family's financial future. It provides peace of mind to policyholders, knowing that their loved ones will receive the full benefit amount without any deductions.

Unit Linked Insurance Plans (ULIPs) offer a range of tax benefits that can help investors save on their tax liabilities while enjoying the dual advantages of insurance and investment. Understanding the tax treatment of ULIPs, including the tax benefits on premiums, exemptions on maturity amounts, and the ULIP tax implications of partial withdrawals and surrender values, is crucial for making informed investment decisions.

ULIPs provide significant tax advantages under Sections 80C and 10(10D) of the Income Tax Act, allowing investors to reduce their taxable income and enjoy tax-free returns on maturity, subject to certain conditions. It is essential to stay updated with the latest tax rules and regulations to maximize the tax benefits and avoid any potential tax liabilities.

By carefully planning their investments and understanding the tax treatment of ULIPs, investors can optimise their tax savings and achieve their financial goals. Whether you are looking to save for your future, provide financial security for your family, or grow your wealth, ULIPs can be an effective investment tool with substantial tax benefits.