Investors can avail themselves of significant tax benefits on the premiums paid towards ULIPs. Under Section 80C of the Income Tax Act, 1961, premiums paid for a ULIP are eligible for tax exemption up to Rs. 1.5 lakh per annum. This deduction is applicable to individual taxpayers and Hindu Undivided Families (HUFs). The premiums paid towards ULIPs help reduce the taxable income, thereby lowering the overall tax liability.
However, it is essential to note that to qualify for this tax benefit, the premium amount should not exceed 10% of the sum assured. If the premium exceeds this threshold, the tax benefit will be limited to 10% of the sum assured. This ensures that the primary purpose of the ULIP remains life insurance rather than just an investment tool for tax savings.
What are the rules of ULIP maturity benefits?
ULIPs or Unit Linked Insurance Plans offer a unique dual benefit — life insurance coverage and market-linked wealth creation. As your policy reaches maturity, understanding the rules governing ULIP maturity benefits becomes crucial for optimising your returns and planning your finances effectively.
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 rules and implications
Understanding the ULIP taxation rules helps investors maximise tax benefits while complying with regulations. The tax treatment of ULIPs has changed over time, particularly with amendments introduced in 2021. Here are the key taxation rules and their implications.
Tax deduction on ULIP premiums:
Premiums paid for ULIPs qualify for deductions under Section 80C, up to Rs. 1.5 lakh annually. However, to claim this benefit, the sum assured must be at least ten times the annual premium.
ULIP tax on maturity benefits:
Under Section 10(10D), maturity proceeds from ULIPs remain tax-free if the annual premium is Rs. 2.5 lakh or less. If the premium exceeds this limit, the returns are taxed as capital gains.
Capital gains tax on high-premium ULIPs:
For ULIP policies issued after 1st February 2021, if the annual premium exceeds Rs. 2.5 lakh, returns are subject to ULIP tax under capital gains tax rules. Equity-oriented ULIPs attract a 10% LTCG tax on gains exceeding Rs. 1 lakh.
Taxation on ULIP partial withdrawals:
Partial withdrawals from ULIPs after the five-year lock-in period are tax-free if they do not exceed 20% of the fund value. This rule ensures liquidity without additional tax burdens.
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 to partial withdrawal of ULIP fund?
Partial withdrawals from a ULIP fund are allowed after the completion of the mandatory lock-in period of five years. The tax treatment of partial withdrawals depends on the conditions of the policy:
Withdrawals up to sum assured:
Partial withdrawals up to the sum assured are exempt from tax. This means that any amount withdrawn within the limit of the sum assured does not attract any tax liability.
Withdrawals exceeding sum assured:
If the partial withdrawal exceeds the sum assured, the excess amount is taxable. The taxable amount is treated as income in the year of withdrawal and is subject to taxation as per the applicable income tax slab rates.
It is crucial for investors to plan their partial withdrawals carefully to maximize the tax benefits and minimize the tax liability.
Also, read: What is ULIP
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.
