ULIP Taxation: Important Points to Understand
ULIPs taxation hits at three critical junctures: premium payment, withdrawal moments, and maturity arrival. This shift in rules depends on when you bought the policy and how much you pay in annual premiums.
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.
ULIP Taxation Rules and Their Implications
The Finance Act of 2021 changed taxation on ULIP. The goal was to align them with mutual funds and maintain equilibrium. High-premium ULIPs over ₹2.5 lakh annually are now treated as investment-centric instruments. Their tax-free advantage is gone, and
the returns are now subject to capital gains taxation.
What are the ULIP Tax Benefits?
ULIPs continue to offer a powerful combination of tax benefits, often referred to as the EEE (Exempt-Exempt-Exempt) status. The new premium rules simply add conditions.
- Exempt (Premium Payment): Your premiums are deductible under Section 80C up to ₹1.5 lakh.
- Exempt (Accumulation): The funds grow tax-free during the policy term.
- Exempt (Maturity/Withdrawal): Maturity proceeds are tax-free under Section 10(10D), but only if the annual premium for new policies stays within the ₹2.5 lakh limit.
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.
Important Amendments Affecting ULIP Taxability
In 2021, the budget amended Section 10(10D) of the Income Tax Act, and the tax treatment of the maturity proceeds of ULIP was changed. Such amendments came into effect on February 1, 2021, impacting the policies issued on or after this date.
When Do ULIP Maturity Proceeds Become Taxable?
The amendment establishes clear boundaries that the maturity amount (bonuses included) forfeits tax exemption when:
- Single Policy Condition: Any year's annual premium breaches ₹2.5 lakh during the policy duration, or
- Multiple Policies Condition: Combined annual premiums across ULIPs collectively exceed ₹2.5 lakh within one financial year.
In these situations, maturity proceeds will be subject to taxation according to the income tax deductions list.
Furthermore, one of the benefits of ULIP is that the policies issued before February 1, 2021, keep their full tax exemption at maturity. The premium amount does not
matter for these older policies. This amendment targeted ULIPs with high-value premiums, aligning them closer to mutual fund norms.
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.
Examples Illustrating ULIP Taxation
Understanding how ULIP plan taxation rules apply in practice can be best achieved through illustrative examples. If you are wondering is ULIP tax free, below are scenarios showcasing the tax treatment of ULIP proceeds based on policy issuance dates and premium amounts.
Example 1: ULIP Purchased Before April 2012
Scenario: Mr. Sharma purchased a ULIP in March 2011.
- Sum Assured: ₹10,00,000
- Annual Premium: ₹1,50,000
- Policy Term: 15 years
- Maturity Value Received in 2026: ₹30,00,000
Tax Analysis For ULIPs issued before April 1, 2012, the primary condition for tax exemption on maturity proceeds under Section 10(10D) is that the annual premium should not exceed 20% of the sum assured.
- 20% of Sum Assured: 20% of ₹10,00,000 = ₹2,00,000.
- Mr. Sharma’s annual premium (₹1,50,000) is less than ₹2,00,000.
Conclusion
The maturity proceeds of ₹30,00,000 received by Mr. Sharma will be entirely tax-exempt under Section 10(10D). The Budget 2021 changes (₹2.5 lakh premium limit) do not apply to policies issued before February 1, 2021.
Example 2: ULIP Purchased After April 2012
Scenario: Ms. Gupta purchased a ULIP in June 2015.
- Sum Assured: ₹15,00,000
- Annual Premium: ₹1,20,000
- Policy Term: 10 years
- Maturity Value Received in 2025: ₹20,00,000
Tax Analysis For ULIPs issued on or after April 1, 2012, but before February 1, 2021, the annual premium must not exceed 10% of the sum assured for maturity proceeds to be tax-exempt under Section 10(10D).
- 10% of Sum Assured: 10% of ₹15,00,000 = ₹1,50,000.
- Ms. Gupta’s annual premium (₹1,20,000) is less than ₹1,50,000.
Conclusion
The maturity proceeds of ₹20,00,000 received by Ms. Gupta will be entirely tax-exempt under Section 10(10D). The Budget 2021 changes regarding the ₹2.5 lakh premium threshold are not applicable here.
Example 3: ULIP Issued After February 2021
Let us consider two scenarios here:
Scenario A: Premium within limits
- Policyholder: Mr. Verma
- Policy Issued: March 2021
- Annual Premium: ₹2,00,000
- Sum Assured: ₹25,00,000 (Annual premium is 8% of Sum Assured, so 10%)
- Maturity Value: ₹35,00,000
Tax Analysis (Scenario A):
- 10% Rule: The annual premium (₹2,00,000) is less than 10% of the sum assured (₹2,50,000). Condition met.
- ₹2.5 Lakh Rule: The aggregate annual premium for ULIPs issued on/after Feb 1, 2021 (here, only one policy) is ₹2,00,000, which is not more than ₹2,50,000. Condition met.
Conclusion (Scenario A): The maturity proceeds of ₹35,00,000 will be tax-exempt under Section 10(10D).
Scenario B: Premium exceeds ₹2.5 lakh
- Policyholder: Ms. Iyer
- Policy Issued: May 2021
- Annual Premium: ₹3,00,000
- Sum Assured: ₹30,00,000 (Annual premium is 10% of Sum Assured. Condition met)
- Total Premiums Paid over term (say 10 years): ₹30,00,000
- Maturity Value: ₹45,00,000
Tax Analysis (Scenario B):
- 10% Rule: The annual premium (₹3,00,000) is equal to 10% of the sum assured (₹3,00,000). Condition met.
- ₹2.5 Lakh Rule: Annual premium (₹3,00,000) exceeds ₹2,50,000.
Conclusion (Scenario B): The maturity proceeds are taxable as per the laws of income tax.
Example 4: Partial Withdrawal Tax Calculation
Scenario: Mr. Kumar purchased a ULIP in April 2021.
- Annual Premium: ₹4,00,000 (exceeds ₹2.5 lakh)
- Sum Assured: ₹40,00,000 (premium is 10% of SA)
- This ULIP’s maturity proceeds will be taxable as per the rules for high-premium ULIPs.
- After 6 years (post lock-in), Mr. Kumar makes a partial withdrawal of ₹5,00,000.
- Cost of units withdrawn (using FIFO or as specified): Let us assume ₹3,50,000 represents the premium attributable to the units being withdrawn.
Tax Analysis Since the annual premium exceeds ₹2.5 lakh, Section 10(10D) exemption is not available for any sum received under this policy (except death benefit). Therefore, partial withdrawals will also be assessed for tax on the gains portion.
- Gain on Partial Withdrawal: ₹5,00,000 (Withdrawal Amount) - ₹3,50,000 (Cost/Premium Attributable) = ₹1,50,000.
- This gain of ₹1,50,000 will be treated as capital gains and taxed as per the income tax laws.
Why did the Government Change the ULIP Tax Rules?
The government changed the rules to level the playing field between ULIPs and mutual funds. This prevents high-net-worth individuals from exploiting high-premium ULIPs as tax-sheltered investment vehicles. The ₹2.5 lakh exemption cap ensures tax benefits
funnel toward genuine insurance requirements rather than large-scale investments disguised as protection products.
Strategies to Save Tax in ULIP
You can still use ULIPs strategically to save tax under the new rules:
- 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 tax 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 these
updated 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 give you a deduction 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 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.
