The popularity of ULIPs exists because of it’s dual-natured benefits. The amount you invest in a ULIP gets divided in two parts – one pays for the life cover, and the remaining is invested in the funds you choose. ULIP offers debt, equity, or a combination of both. Your choice depends on your premium affordability, risk appetite and future goals.
Is There Taxation On ULIPs?
One of ULIP’s winning features is the ULIP tax deduction structure, which helps you save on taxes!
- Get tax deductions on annual premiums of up to Rs 1.5 lakh/year with Section 80C of Income-tax Act, 1961 (Act).
- At policy maturity, you enjoy tax-free proceeds under Section 10(10D) of the Act, subject to terms and conditions being met.
- The death benefit payout is tax-free.
These tax-saving benefits translate to more savings for you, which you can further reinvest to earn more dividends. However, some tax on your ULIP gains is still levied, depending on the year of purchase and total premium payable.
Types Of Taxes Applicable And Eligible Deductions For ULIPs
You can claim deductions on your premiums paid under Section 80C, and receive ULIP maturity taxability tax benefits deduction under Section 10(10D) of Act, , subject to the following conditions:
For ULIPs purchased before April 1, 2012
- If the premium amount is less than 20% of the actual capital sum assured, you can benefit from deduction of the total annual premium paid under Section 80C.
- If the premium exceeds 20% of the actual capital sum assured, you can claim a deduction on the amount equal to 20% of the actual capital sum assured.
For ULIPs purchased after April 1, 2012
- Deduction on total annual premiums paid under Section 80C can only be claimed if the premium amount is less than 10% of the actual capital sum assured.
- If the premium exceeds 10% of the actual capital sum assured, you can avail a deduction on the amount equal to 10% of the actual capital sum assured.
Maturity benefits for ULIPs purchased before February 1, 2021
Maturity benefits are tax-free under Section 10(10D of the Act). However, whether the gains from a ULIP are taxable or not and to what extent is subject to the following conditions:
- For ULIPs purchased before April 1, 2012 - the premium amount is less than 20% of the actual capital sum assured
- For ULIPs purchased after April 1, 2012 - the premium amount is less than 10% of the actual capital sum assured
Update on Taxation on ULIP’s Issued After February 1, 2021
An exemption under section 10(10D) of the Act shall not apply for ULIP policies (Non-Exempt ULIP) issued on or after 1 February, 2021, if the amount of premium payable for single/in aggregate for any of the previous year during the term of the policy exceeds INR 2,50,000. Such Non-Exempt ULIPs’ are considered as “Capital Asset” under section 2(14) of the Act.
Any gains arising from Non-Exempt ULIP shall be taxable as “Capital Gains” following the computation mechanism prescribed under the relevant provisions of the Act.
The existing condition of premium amount should not be more that 10% of capital sum assured to avail the exemption under section 10(10D) of the Act.
The lumpsum received as death benefit is tax-free under Section 10(10D) of Act.
Taxation on Surrender of ULIPs
Surrendering a ULIP before the completion of the policy term has specific ULIP taxation implications.
Before the lock-in period ends:
If you surrender the policy within the first five years (i.e., before the lock-in period ends), the entire maturity amount received is added to your income for that year. It is taxed as per your applicable income tax slab. It also leads to a drawback of any ULIP tax deduction you had previously claimed under Section 80C.
After the lock-in period ends:
For policies surrendered after five years, the ULIP taxation rules treat the proceeds differently. The gain, which is the amount received minus the total premiums paid, is considered a long-term capital gain (LTCG).
For policies (issued after February 1, 2021), where the premium exceeds ₹2.5 lakh annually, this gain is taxable at 12.5%.
Understanding these ULIP plan taxation rules can help you avoid unexpected tax liabilities if you are planning to exit a policy prematurely.
Update as per Union Budget 2025
The Union Budget for FY 2025-26 was presented on February 1, 2025. Finance Minister Nirmala Sitharaman introduced new ULIP taxation rules. Effective from April 1, 2026, ULIPs with annual premiums exceeding ₹2.5 lakh will be subject to long-term capital gains (LTCG) tax at a rate of 12.5% if held for more than one year.
1. Taxation on High-Premium ULIPs:
ULIPs purchased after February 1, 2021, with annual premiums exceeding ₹2.5 lakh, will no longer enjoy tax exemption under Section 10(10D) of the Income Tax Act. Instead, gains from these policies will be taxed as capital gains upon redemption.
2. Capital Gains Tax Rates:
Long-Term Capital Gains (LTCG):
For policies held for more than 12 months, gains will be taxed at 12.5%. This reduced rate on long-term holdings signals a nuanced approach to encourage investors to maintain a long-term perspective on their investments. By doing so, the government is also promoting long-term economic stability and investment in financial products that contribute to sustained financial growth.
Short-Term Capital Gains (STCG):
For policies held for 12 months or less, gains will be taxed at 20%. The higher rate for short-term gains indicates an effort to dissuade speculative investments and encourage investors to hold onto their investments for longer periods. This structure is in line with the broader objective of reducing market volatility by discouraging frequent trading.
To make sure the premiums for your chosen sum assured are within your budget and fit into your tax strategy, use a unit-linked insurance plan calculator. It gives you premium estimates, so you can curate your tax planning accordingly.
Taxation on Partial Withdrawals
There is no tax on a ULIP’s partial withdrawals, provided the policy has completed its lock-in period. This makes partial withdrawals an attractive feature for meeting intermediate financial goals without incurring a tax on ULIP gains. However, it is critical to ensure that the withdrawal does not deplete the fund’s value and keep the 20% limit in mind.
Strategic Considerations for managing ULIPs in 2025 and beyond
Investors holding high-premium ULIPs should reassess their portfolios and consider the ULIP taxation implications of their investment strategies. Investors should also look at ULIPs from a perspective of wealth-creation and security, for better portfolio management and long-term investment planning.
The following steps can be implemented to fit ULIP into a successful financial portfolio:
1. Policy Evaluation
Review existing ULIP holdings. Determine if the annual premium exceeds the ₹2.5 lakh threshold and understand the potential tax liabilities upon redemption. Investors must be proactive in assessing which policies may now incur additional taxes. They should consider whether these policies remain beneficial within their overall financial plans.
2. Horizon-based Planning
Given the new tax structure, a longer investment horizon may be beneficial to optimize post-tax returns, especially considering the LTCG tax rate of 12.5% for holdings beyond one year. Investors may need to recalibrate their investment timelines to align with these changes. They should ensure that their investment strategies remain in line with their financial goals and the new ULIP taxation landscape. A ULIP calculator can be used to analyse and plan investments and timelines in advance.
3. Diversification
Explore a diversified investment approach. Balance ULIPs with other financial instruments to achieve financial goals while managing tax liabilities effectively. Diversification remains a prudent strategy in managing risk and achieving a balanced portfolio in light of these fiscal changes.
Tips to manage ULIP taxation
Clearly, under the right conditions, ULIPs offers tax benefits. Here’s how you can leverage them to optimise your tax planning:
Save your taxable income:
Aim for the ₹1.5 lakh premium limit as this will give you higher tax benefits and higher life coverage. For example, paying a premium of ₹1 lakh will lower your taxable income by ₹1 lakh.
Get more on maturity:
Avoid tax on ULIP maturity benefits and death benefits by keeping the annual premium value within ₹2.5 lakh.
Stay invested for at least 5 years:
To avail ULIP tax benefits under section 80C, stay invested for 5 years. Otherwise, the deduction availed in the previous year is added back to your taxable income.
Leverage market volatility:
Switch funds to one that offers better tax efficiency.
Research on ULIP charges
Be mindful of the ULIP charges, such as premium allocation and fund management charges. While these do not have a direct tax impact, higher charges can reduce your overall net returns. This can affect the efficiency of your tax-saving investment. Some of the best ULIP plans in the market come with minimal or no allocation and fund management charges.
Understanding ULIP taxation norms is key to maximising your returns from the plan. By being clear on what a ULIP plan is, the rules under Sections 80C and 10(10D), the implications of high-premium policies, and the tax treatment of withdrawals and surrenders, you can make informed decisions. A ULIP remains a powerful tool for combined insurance and investment. With strategic planning, you can optimise its benefits for long-term wealth creation and financial security.
FAQs
1. Is the interest or growth in a ULIP tax-free?
The growth or returns generated within a ULIP are tax-free upon maturity or as a death benefit, provided the policy meets the conditions prescribed under Section 10(10D) of the Income Tax Act, 1961. This includes the requirement that the premium paid is within 10% of the sum assured for most policies.
2. What is the minimum tax exemption I can claim for a ULIP?
There is no minimum limit for the ULIP tax deduction you can claim. The deduction under Section 80C is based on the actual premium you pay, up to a maximum aggregate limit of ₹1.5 lakh per financial year (which includes other eligible investments).
3. What are the tax implications if I stop my ULIP premiums?
If you stop paying premiums and the policy lapses before completing five years, the ULIP tax deduction claimed in previous years will be added back to your income and taxed. Additionally, any amount received upon surrender will be taxable.
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