Tax on ULIP (Unit-Linked Insurance Plans)

Unit Linked Insurance Plans (ULIPs) are a unique financial product that combines investment and insurance, offering policyholders the dual benefit of wealth creation and life coverage. Traditionally, ULIP proceeds enjoyed favourable tax treatment, but Budget 2025 proposes significant changes. Under the new classification, ULIPs will be treated as capital assets, and their proceeds will be taxed under capital gains instead of income from other sources. This shift impacts individuals using ULIPs for retirement savings, higher education, or house purchases, making it essential to understand the revised tax implications. This article will comprehensively explore the Tax on ULIP, its previous taxation treatment and its shift in taxability of ULIP in Budget 2025. 

What is ULIP?

The full form of ULIP is the "Unit Linked Insurance Plan". A Unit Linked Insurance Plan (ULIP) is a life insurance product that combines investment and insurance benefits. A portion of the premium paid is allocated to life insurance coverage, ensuring financial protection for your family, while the remaining amount is invested in market-linked funds of your choice, such as equity, debt, or a mix of both. This flexibility allows you to align your investment with your risk appetite and long-term financial goals. ULIPs serve as an ideal option for individuals seeking both wealth creation and life protection in a single plan.

Benefits of ULIP (Unit-Linked Insurance Plans)

The following are the typical benefits one can attain by opting for the ULIP:

• Dual Benefit of Insurance and Investment: ULIPs provide the advantage of both life insurance coverage and investment opportunities. While a portion of the premium ensures financial protection for your family, the remaining amount is invested in market-linked funds.
• Choice of Investment Funds: You can choose to invest in equity, debt, or a combination of both based on your risk appetite and financial goals. This flexibility allows you to optimize returns according to market performance.
• Market-Linked Returns: Unlike traditional insurance plans, ULIPs offer the potential for higher returns as they invest in market-linked funds. This helps in wealth creation over the long term.
• ULIP Tax Benefits: ULIP plan tax benefits are available as such premiums paid towards ULIPs qualify for tax deductions under Section 80C of the Income Tax Act, and the maturity proceeds may also be tax-exempt under Section 10(10D), subject to certain conditions.
• Partial Withdrawal Option: ULIPs offer liquidity through partial withdrawals after the lock-in period, making it easier to meet financial emergencies without affecting the entire investment.
• Fund Switching Flexibility: Investors can switch between equity and debt funds based on market conditions and risk tolerance. This allows for active portfolio management and better risk control.

Taxability of ULIP

Unit Linked Insurance Plans (ULIPs) offer tax benefits under the Income Tax Act 1961. The premiums paid towards a ULIP are eligible for deductions under Section 80C, subject to specific conditions and limits. 

Tax Deductions on ULIP Premiums (Section 80C)

• The maximum deduction allowed under Section 80C is ₹1.5 lakh per year. However, this limit is shared with other eligible investments and expenses, including ULIP premiums.
• The tax deduction eligibility depends on whether the ULIP was purchased before or after April 1, 2012.

ULIPs Purchased After April 1, 2012

• To claim a deduction under Section 80C, the annual premium must be less than 10% of the sum assured.
• If the premium exceeds 10% of the sum assured, only the amount up to 10% of the sum assured qualifies for a tax deduction.

ULIPs Purchased Before April 1, 2012

• The premium threshold for tax deduction under Section 80C is 20% of the sum assured for policies purchased before this date.
• If the annual premium exceeds 20% of the sum assured, the deduction is limited to 20% of the sum assured.

Taxability of ULIP on Maturity

The taxation of Unit Linked Insurance Plans (ULIPs) at maturity is governed by specific provisions under the Income Tax Act, of 1961. While the premiums paid towards ULIPs qualify for deductions under Section 80C, the maturity proceeds are also regarded as a ULIP tax exemption under Section 10(10D), subject to certain conditions.

Tax Rules for ULIP Maturity Benefits

• ULIPs Issued on or Before February 1, 2021:
• Maturity benefits from ULIPs issued on or before this date are tax-free under Section 10(10D), regardless of the total premiums paid during the policy term.
• ULIPs Issued on or After February 1, 2021:
• If the annual premium for the ULIP remains below ₹2.5 lakh throughout the policy tenure, the maturity proceeds are tax-exempt under Section 10(10D).
• If the annual premium exceeds ₹2.5 lakh in any policy year, the maturity benefits become taxable, as per the fourth proviso of Section 10(10D).
• Taxation of Multiple ULIPs (Issued on or After February 1, 2021):
• If the total annual premium for all ULIPs remains below ₹2.5 lakh, then the maturity proceeds of each ULIP are tax-free under Section 10(10D).
• If the combined annual premium for all ULIPs exceeds ₹2.5 lakh, only those policies with a total premium below ₹2.5 lakh will have tax-free maturity benefits. The maturity proceeds of the remaining policies will be taxable.
• Taxation in Case of Death:
• The amount received by the nominee in the event of the policyholder’s death is fully tax-exempt under Section 10(10D), irrespective of the premium amount.

Budget 2025 Update Regarding ULIP Taxation

The Union Budget 2025 has introduced a key clarification regarding the taxation of Unit Linked Insurance Policies (ULIPs). It has been proposed that any profits or gains arising from the redemption of ULIPs not eligible for exemption under Section 10(10D), will be taxed as capital gains.

This amendment aims to remove ambiguity in the taxation of ULIP proceeds and ensure uniformity in tax treatment. The changes will be effective from April 1, 2026, and will apply to the assessment year 2026-27 and subsequent years.

How is the ULIP Taxed as per Budget 2025 Decision?

 The Budget 2025 has introduced significant changes to the taxation of Unit Linked Insurance Policies (ULIPs). Under the revised framework, ULIPs with annual premiums exceeding ₹2.5 lakh will no longer qualify for tax exemption under Section 10(10D) of the Income Tax Act, 1961. Instead, these policies will now be taxed as capital gains under Section 112A. Capital gains refer to the profit earned from the sale of a capital asset, such as stocks or property. As per the Finance Minister's proposal in Budget 2025, ULIP will be classified as capital gains and taxed accordingly.

If the ULIP is held for more than 12 months, its redemption will be classified as a long-term capital asset, attracting a 12.5% tax. This move builds upon the 2021 Budget, which initially introduced taxation on high-premium ULIPs but left ambiguity regarding their tax treatment upon redemption.

The Finance Bill 2025 clarifies this by explicitly stating that proceeds from ULIPs not eligible for Section 10(10D) exemption will be subject to capital gains tax. These changes will take effect from April 1, 2026, impacting the assessment year 2026-27 and beyond.

This new tax framework ensures consistency by aligning ULIP taxation with equity mutual funds and other capital market instruments. While it provides clarity, it may impact investors who previously used ULIPs for tax-efficient wealth accumulation, as their returns will now be subject to capital gains tax.

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Conclusion

In conclusion, the Budget 2025 has redefined the taxation of ULIPs, ensuring clarity by taxing high-premium policies under capital gains. While this aligns ULIPs with other capital market instruments, it may affect investors who previously leveraged them for tax-efficient wealth accumulation. As these changes take effect from April 1, 2026, policyholders must carefully evaluate their investment decisions in light of the revised tax framework.

FAQs

1. What is the tax benefit of investing in ULIPs?

Premiums paid for ULIPs qualify for deductions under Section 80C, and maturity proceeds may be tax-exempt under Section 10(10D), subject to certain conditions.

2. How has the tax on ULIPs changed under Budget 2025?

Budget 2025 classifies ULIPs as capital assets, meaning their maturity proceeds will be taxed under capital gains instead of being tax-free.

3. What is the tax treatment for ULIPs with annual premiums below ₹2.5 lakh?

If the annual premium remains below ₹2.5 lakh, the maturity proceeds remain tax-free under Section 10(10D) of the Income Tax Act.

4. How are ULIPs with annual premiums exceeding ₹2.5 lakh taxed?

ULIPs exceeding ₹2.5 lakh in annual premium will be taxed as capital gains under Section 112A, with a 12.5% tax rate on long-term gains.

5. Does the new tax rule apply to all ULIPs?

No, the new tax rule applies only to ULIPs issued on or after February 1, 2021, where the total premium exceeds ₹2.5 lakh annually.

6. What happens if I hold multiple ULIPs with a combined premium above ₹2.5 lakh?

If the total annual premium across all ULIPs exceeds ₹2.5 lakh, only policies below this limit will enjoy tax-free maturity, while others will be taxed under capital gains.

7. Is the death benefit from ULIPs taxable?

No, the nominee receives the death benefit completely tax-free under Section 10(10D), regardless of the premium amount.

8. When will the new ULIP taxation rules come into effect?

The new taxation framework will be effective from April 1, 2026, impacting the assessment year 2026-27 and beyond.

9. Can I switch funds within my ULIP without tax implications?

Yes, fund switching within ULIPs (e.g., from equity to debt) is not taxed as long as the policy remains active.

10. How should ULIP investors adapt to the new tax changes?

Investors should evaluate alternative investment options, consider splitting premiums across policies, and consult financial advisors for tax-efficient planning under the new regime.

11. What could be the rationale behind the taxation changes in Budget 2025?

The changes build on the Finance Act 2021, which restricted tax exemptions for ULIPs with premiums exceeding ₹2.5 lakh. The goal is to prevent high-value investment products from being misused as tax-saving vehicles under the guise of life insurance policies.

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