Is There Tax On ULIPs?
Yes, ULIPs can attract tax, yet they still offer strong avenues for savings. Taxation depends on multiple variables, such as purchase date, premium amount, and the structure of the policy. Most ULIPs historically enjoyed Exempt-Exempt-Exempt (EEE) tax status, but recent amendments have introduced some important conditions that you must be aware of.
Types of Taxes Applicable and Eligible Deductions For ULIPs
Three distinct stages govern ULIP tax treatment: investment phase, accumulation phase, and withdrawal phase. Each operates under different rules that interlock yet remain separate in their application.
- At the Time of Investment (Premium Payment)
Section 80C of the Income Tax Act, 1961 permits deductions on ULIP premiums from your taxable income, with a maximum deduction of ₹1.5 lakh per financial year. This is straightforward: you pay premiums, you claim deductions, and you reduce tax burden.
- At the Time of Maturity/Withdrawal
Section 10(10D) typically exempts ULIP maturity proceeds from taxation. For policies issued after February 1, 2021, though, this exemption is applicable only when the total annual premium is up to ₹2.5 lakh. If the annual premium crosses that threshold, the returns will be subjected to capital gains tax.
- Death Benefit
Death benefits paid to nominees carry a complete tax-free status under Section 10(10D), irrespective of premium amounts or policy vintage. It offers pure exemption when tragedy strikes, and beneficiaries need protection most, with no exceptions or conditions.
For ULIPs Purchased Before April 1, 2012
For ULIPs purchased on or before March 31, 2012, the tax deduction on premiums under Section 80C could be claimed as long as the premium amount was not more than 20% of the capital sum assured. This was a more lenient rule that applied to older policies.
For ULIPs Purchased After April 1, 2012
Following a regulatory change, for all ULIP policies purchased on or after April 1, 2012, the condition for claiming the Section 80C benefit was made more stringent. To be eligible for the tax deduction, the annual premium payable could not exceed 10% of the capital sum assured. This is the standard rule that applies to most ULIPs today.
Maturity Benefits for ULIPs Purchased Before February 1, 2021
This is a critical distinction that differentiates older policies from the new tax rule. For any ULIP that was purchased on or before January 31, 2021, the new taxation rule introduced in the Union Budget 2021 does not apply.
This means that for these policies, the maturity proceeds
remain completely tax-free under Section 10(10D), regardless of how high the annual premium is, as long as it complies with the 10% or 20% premium-to-sum-assured rule. This no TDS on ULIP maturity provides significant relief and protects the tax-free status for existing high-premium ULIP policyholders.
Latest Budget 2025 Updates on ULIP Taxation
The Union Budget 2025 introduced pivotal shifts affecting ULIP plans taxation. This makes the investors and policyholders face new parameters now, as compared to the previous regimes. Below is a breakdown of the latest updates regarding ULIP tax exemption:
Previous Tax Rule (Before Budget 2025)
A ULIP was a capital asset only when the annual premium was over ₹2.5 lakh. The premiums below this limit meant maturity proceeds were tax-free under Section 10(10D).
Revised Tax Rule (Budget 2025 Update)
The rules have expanded. ULIPs with premiums over 10% of the sum assured are now also capital assets, making their gains taxable if redeemed before the five-year lock-in.
Your maturity or withdrawal amount stays tax-free as long as your annual premium is under ₹2.5 lakh and the policy meets all other exemption criteria.
ULIP Taxation: Important Points to Understand
Taxation strikes at three junctures: premium payment, withdrawal instances, and maturity arrival. This shift in rule depends heavily on purchase timing and annual premium commitment.
Tax Benefits Available On ULIP Premiums
Premium payments unlock Section 80C deductions under the Income Tax Act, 1961. The maximum deductions allowed are ₹1.5 lakh annually. You can claim this exemption as long as the premium amount does not exceed 10% of the sum assured. If you stay within that boundary, you can claim your relief.
Tax Rules For ULIP Maturity Proceeds
Section 10(10D) typically exempts maturity amounts. But new rules apply for tax on ULIP maturity. For policies issued after February 1, 2021, you only get the tax exemption if your total annual premium is below ₹2.5 lakh. If you go over that limit, you may have to pay capital gains tax.
Capital Gains Tax On ULIP Withdrawals
If your annual premium on a new ULIP exceeds ₹2.5 lakh, your returns are not tax-free. The tax treatment is similar to that of equity mutual funds.
- Long-Term Capital Gains (LTCG): If the units are held for more than one year, gains exceeding ₹1 lakh in a financial year are taxed at 12.5%.
- Short-Term Capital Gains (STCG): If the units are held for less than one year, gains are taxed at 20%.
Tax Treatment of Partial Withdrawals from ULIPs
If the five-year lock-in expires, partial withdrawals become possible from ULIPs. Tax-free status applies if the withdrawal stays within 20% of the fund value. However, the ₹2.5 lakh annual premium ceiling for post-February 2021 policies governs everything here too.
How Is Tax Calculated on Partial Withdrawals from ULIPs?
Partial withdrawals follow a simple rule. If your annual premium is under ₹2.5 lakh, withdrawals after five years are tax-free.
If your premium is over ₹2.5 lakh, you pay capital gains tax on the profit from any withdrawal. Withdraw ₹3 lakh on a ₹2.5 lakh investment, and your taxable gain is ₹50,000. This is taxed at STCG or LTCG rates based on how long you held the units.
How Is Tax Calculated on Surrender Value from ULIPs?
Surrendering a ULIP before the five-year lock-in period has clear consequences. The entire surrender value gets added to your income and taxed at your slab rate. Surrender after five years, and the maturity rules apply. It is tax-free if your premium is under the ₹2.5 lakh limit or taxed as capital gains if it exceeds the limit.
Is the Death Benefit Under a ULIP Tax-Free?
Yes, absolutely. Nominees receive the death benefit completely tax-exempt under Section 10(10D). The premium amount becomes irrelevant here, and this rule spans all ULIP policies universally, irrespective of the premium amount, with no exceptions whatsoever.
Strategies to Save Tax in ULIP
Although there are taxation rules on ULIPs, you can still use various strategies to save tax under the new rules to maximize the benefits of ULIP:
- Keep Premiums Below ₹2.5 Lakh: To enjoy tax-free returns, make sure that the total premium of all ULIPs is not more than ₹2.5 lakh.
- Utilize Section 80C: Use the Section 80C deduction on your premium payments. This reduces your taxable income by up to ₹1.5 lakh.
- Long-Term Investment Horizon: Hold your ULIP gains for more than a year. In this way, you are going to pay the lower 12.5% rate of LTCG, rather than the higher 20% rate of STCG.
Conclusion
ULIPs are still powerful tools for wealth and protection. The ULIP taxation rules have changed, but major advantages remain if you follow the premium limits. The death benefit is always tax-free, securing its primary role as life insurance. Understanding updated ULIP plan taxation regulations empowers informed decisions, aligning ULIP investments with financial objectives effectively and intelligently.
FAQs on ULIP Taxation
1
Are ULIP premiums eligible for tax deduction?
Yes, ULIP premiums are eligible under the income tax deductions list under Section 80C up to ₹1.5 lakh. For policies issued after April 1, 2012, your annual premium must be 10% or less of the sum assured to avail this exemption.
2
Is the maturity amount from ULIPs tax-free?
The taxability of ULIP on maturity depends. Generally, yes, under Section 10(10D), if the annual premium is within 10% of the sum assured (20% for policies before April 2012). However, for ULIPs issued on or after February 1, 2021, if the aggregate annual premium exceeds ₹2.5 lakh, the ULIP maturity taxability becomes liable as capital gains.
3
What happens if I surrender my ULIP before 5 years?
If surrendered before the 5-year lock-in:
- Any Section 80C deductions claimed previously will be reversed and added to your taxable income in the year of surrender.
- The entire surrender value (paid out after the 5-year lock-in completes) becomes fully taxable.
4
Are partial withdrawals taxable?
If the ULIP’s maturity proceeds are tax-exempt, partial withdrawals after the 5-year lock-in are generally tax-free. For high-premium ULIPs, where maturity is taxable, partial withdrawals are also taxable on the gains component.
5
How has Budget 2025 changed ULIP taxation?
Budget 2025 proposals introduce a 12.5% long-term capital gains tax on post-one-year withdrawals for ULIP investors maintaining annual premiums above ₹2.5 lakh. Section 112A governs this taxation regardless of fund equity/debt allocation, making a significant shift from previous treatment entirely.
