ULIP Taxation

Table of Content

1. What is a ULIP?

2. Understanding Taxation in ULIP

3. Tax on ULIPs: Key Considerations

4. ULIP Tax Benefits

5. ULIP Taxation Rules and Implications

6. ULIP Tax Planning Strategies

7. Conclusion

8. FAQs on Ulip Taxation 

What is a ULIP?

A Unit Linked Insurance Plan (ULIP) is a financial product that combines life insurance with market-linked investment. In a ULIP, a portion of the premium is allocated for life insurance coverage, while the remainder is invested in equity, debt, or balanced funds. 

Understanding Taxation in ULIP

ULIP taxation depends on several factors, including the annual premium amount, the number of ULIP policies held, and the type of payout, whether it is maturity, surrender, or death benefit. Premiums paid on ULIP policy can be qualified for deductions under Section 80C* of the Income Tax Act 1961, upto Rs. 1.5 lakhs annually, while maturity benefits are exempt from tax under Section 10(10D)* of the Income Tax Act, 1961, subject to conditions prescribed and death proceeds are completely tax-free.

Previously, the maturity proceeds of ULIPs issued on or after 1st April 2012 were completely tax -free, unless the premium payable for any of the year during the policy term exceeded 10% of the actual capital sum assured however, since February 1, 2021, ULIPs with annual premiums exceeding ₹2.5 lakh is also taxable under the head “Income from Capital Gains”. This change aligns the taxation of ULIPs with that of mutual funds. It is important to note that death benefits from ULIPs remain completely tax-free under Section 10(10D)* of the Income Tax Act, 1961, regardless of the premium amount or the terms of the policy.

Tax on ULIPs: Key Considerations

ULIP taxation is imposed on three primary levels: premium payments, early withdrawals, and maturity proceeds. Recognizing these levels enables investors to make knowledge-based choices and maximize tax effectiveness throughout the policy duration.

Tax Benefits of Payment of ULIP Premiums

Taxation on ULIP premiums is eligible for tax deduction under Section 80C* of the Income Tax Act,1961 up to ₹1.5 lakh a year subject to the aggregate limit of Rs.1,50,000. The deductibility is within the overall limit allowed under Section 80C*, which also covers other investments such as PPF, ELSS, and EPF, tuition fee etc.

However, the tax benefit shall be limited to 10% of the sum assured or actual premiums payable whichever is less for policies taken after 1 April 2012. In case of policies issued before April 1, 2012 this limit shall be 20%.  Tax Implications on ULIP Withdrawals

Withdrawals from a ULIP after completing the minimum 5-year lock-in period will have tax consequences if conditions under Section 10(10D)* are not met. The surrender amount is taxed under the head “Income from Capital Gain”.

Taxation on ULIP Maturity Proceeds

The tax rate on ULIP maturity proceeds depends on the annual premium paid in all ULIPs owned by the policyholder. If the aggregate premium does not exceed ₹2.5 lakh in a financial year and the premium on each ULIP is less than 10% of the sum assured, then the maturity amount qualifies for exemption under Section 10(10D)* of the Income Tax Act, 1961.

However, if the overall premium exceeds ₹2.5 lakh/year, profits for non-qualifying ULIPs shall be taxed as Long Term Capital Gains (LTCG) at 12.5% over gains of ₹1.25 lakh. For instance, ₹12 lakh received – ₹8 lakh premium = ₹4 lakh gain; ₹2.75 lakh is taxed at 12.5%. Death benefits continue to be completely tax-free.

How the Finance Act 2021 Changed ULIP Taxation

The Finance Act of 2021 introduced significant changes to the taxation of ULIP plans by amending Section 10(10D)* of the Income Tax Act,1961. For ULIPs issued on or after February 1, 2021, this amendment removes the tax exemption on maturity proceeds for policies where the total annual premium across all ULIPs exceeds ₹2.5 lakh.

In such cases, the maturity proceeds will be taxed as Income from Capital Gains, similar to equity-oriented mutual funds, on any gains exceeding ₹1.25 lakh, without the benefit of indexation.

Budget 2025 Update

The ₹2.5 lakh cap applies to the total premium paid on all ULIPs (Unit-Linked Insurance Plans) by a policyholder within a financial year, not on each policy. This policy change was implemented to prevent tax arbitrage, where wealthy individuals were using ULIPs as tax-free investment vehicles.

However, it is important to note that death benefits under ULIPs remain completely tax-free, regardless of the premium amount or the policy issue date.

How is ULIP Taxed According to the Budget 2025 Decision?

The Union Budget 2025 has brought in a clarification under Section 10(10D)* for ULIP maturity proceeds that even if the annual premium does not exceed ₹2.5 lakh, but once the limit of 10% of amount assured is crossed, the whole maturity amount is taxed under the head “Income from capital gain”. This step also brings ULIPs more in line with conventional life insurance taxation practices. However, death benefits will continue to be tax-free.

ULIP Tax Benefits

ULIPs offer tax deductions on premiums paid under Section 80C*, up to ₹1.5 lakh annually. Moreover, maturity proceeds are tax-free under Section 10(10D)* subject to conditions prescribed, which increases long-term tax efficiency.

Tax Deduction on Premiums Paid [Section 80C]

Premiums paid towards ULIPs are allowed as deduction under Section 80C* of the Income Tax Act,1961 providing a potential relief of up to ₹1.5 lakh in that financial year. The deduction reduces the policyholder’s taxable income, making ULIPs a tax-effective investment vehicle.

ULIPs combine insurance with investment benefits and facilitate long-term wealth accumulation. They also provide immediate tax relief each year and encourage disciplined financial behaviour throughout the policy period.

Tax Exemption on Death Benefit [Section 10(10D)]

The death benefit that is taken from a ULIP comes completely free of tax through Section 10(10D)* of the Income Tax Act, 1961. The exemption includes both the amount assured and the built-up fund value or bonuses, so the nominee gets the entire benefit tax-free.

It is an important financial protection for the family, providing peace of mind and facilitating a smooth, tax-free inheritance. This section enhances the safeguarding benefits of ULIPs, highlighting their role in long-term financial planning.

Is ULIP Tax-Free?

ULIP maturity proceeds received in the current year may be either tax-free or taxable, depending on the policy issue date and premium conditions. The table below summarises the applicable tax treatment under various scenarios:

To remain tax-exempt under Section 10(10D)* of the Income Tax Act, 1961, ULIP maturity proceeds must meet the required sum-assured-to-premium ratio, regardless of the issue date. Death benefits are always tax-free, and investors can use a ULIP calculator to estimate post-tax returns accurately.

ULIP Taxation Rules and Implications

ULIPs offer a combination of insurance coverage and investment returns, making it essential to understand their tax treatment for effective financial planning. The following sections outline the key tax regulations related to ULIPs, including premium deductions, maturity exemptions, long-term capital gains (LTCG) implications, and the handling of death benefits.

Premium Payment Tax Benefits

ULIPs are treated as insurance investments for tax purposes under Section 80C* of the Income Tax Act and can claim tax deduction on premium payments. Policyholders can avail deductions for ₹1.5 lakh annually, for annual premium that does not exceed 10% of the sum assured (for policies taken on or after 1 April 2012). This reduces overall taxable income.

Maturity Proceeds Taxability

Taxability of ULIP maturity proceeds is based on the policy’s issue date and the premium value. For policies taken after 1 February 2021, maturity is tax-free only if the sum paid as annual premium is ₹2.5 lakh or below and not more than 10% of the sum assured. Otherwise, proceeds are subject to tax as long-term capital gains under Section 112A.

Death Benefit Tax Exemption

Death benefit under a ULIP is the amount paid to the nominee in case the policyholder dies within the policy term. This benefit consists of the sum assured and available fund value or bonuses, whichever applies, and is completely exempt from tax under Section 10(10D)* of the Income Tax Act.

The exemption is even if the annual premium is high or the sum assured to premium ratio is high. This renders ULIPs a secure financial asset, providing tax-free wealth transfer and protection for the nominee.

Withdrawals/Surrender Tax Implications

ULIPs have a lock-in period of five years from when the policy is issued. If you return the policy post lock in the surrender value less the premiums shall be taxable as “Income from Capital Gains” if Section 10(10D)* conditions are not met.

TDS can be applicable in case the policy does not satisfy Section 10(10D)* conditions, especially when the premium exceeds 10% of the sum assured. In such cases, the maturity proceeds become taxable, and TDS under Section 194DA is deducted at 2% on the net income component (i.e., maturity amount minus total premiums paid).

However, if the policy continues to meet the conditions of Section 10(10D)*, then any partial withdrawals made are exempt from the tax.

ULIP Tax Planning Strategies

ULIP taxation planning strategies help investors reduce tax incidence and get maximum returns on their policies. Policyholders can ensure enhanced long-term tax efficiency and wealth accumulation through carefully crafted premiums, the facility of fund switching, and maintaining within the exemption limits.

Maximise The Benefits Available Under Section 80C

Premiums paid for ULIPs qualify for deductions under Section 80C* up to ₹1.5 lakh annually, which reduces one's taxable income for the financial year. Such a deduction also helps long-term planning towards investments because ULIPs are subject to a 5-year lock-in. Therefore, investors can try using this limit to the fullest if other investments under Section 80C* have not exhausted the limit.

Utilize the Tax-Free Maturity

ULIPs can offer tax-free maturity proceeds under Section 10(10D)* if the annual premium is below ₹2.5 lakh (for policies issued after February 2021) and fulfils the necessary sum-assured norms for older policies (like 10% of sum assured for older policies). Investors should carefully read policy conditions and pay premiums to stay within the exemption limits. This approach allows for strategic wealth building while ensuring long-term tax efficiency and optimal post-tax returns.

Use The Fund Switching Facility Wisely

ULIPs provide the facility for switching between equity, debt, or balanced funds without paying capital gains tax. This tax-free aspect facilitates aligning your investment with evolving market scenarios and risk appetite, which is more beneficial compared to mutual funds, where switching between funds is taxable. Switching annually to review fund performance or a strategic switch can maximise returns while being tax-efficient in the long run.

Understanding ULIP Taxation with Practical Examples

Real-life examples help comprehend ULIP taxation better under various scenarios. For example, suppose a policyholder pays an annual premium of ₹2 lakh for 10 years and gets ₹30 lakh at maturity. The whole amount is tax-exempt if the premium is less than Rs 2.5 lakhs and premium is not exceeding 10% of the sum assured. However, if the annual premium was ₹3 lakh, higher than the ₹2.5 lakh threshold, the gains would be taxable as long-term capital gains (LTCG) at 12.5% over ₹1.25 lakh.

Example 1:

This example illustrates how annual premium amounts affect ULIP taxation after maturity under Section 10(10D)*, especially after the 2021 budget update.

Aman: His annual premium is below ₹2.5 lakh, so his maturity amount is fully exempt under Section 10(10D)*.

Boney: His annual premium exceeds ₹2.5 lakh/year, so the exemption does not apply.

Capital Gains: ₹48 lakh – ₹26 lakh = ₹22 lakh

Taxable LTCG: ₹22 lakh – ₹1.25 lakh = ₹20.75 lakh

Tax at 12.5%: ₹2.6 lakh (plus applicable surcharge and cess)

Insight: Paying premiums above ₹2.5 lakh makes ULIP maturity proceeds taxable even for equity-oriented policies.

Example 2:

This example illustrates how Section 10(10D)* tax exemption works for policies bought on or after 1 February 2021 when the annual premium stays within ₹2.5 lakh.

● Date of Purchase: 1 November 2021

● Annual Premium: ₹2.5 lakh

● Sum Assured: ₹25 lakh

● Policy Term & Maturity Date: 10 years, ending on 1 November 2031

● Maturity Value Received: ₹32 lakh

Since the annual premium does not exceed ₹2.5 lakh, the entire ₹32 lakh maturity amount is tax-free under Section 10(10D)*.

Insight: Staying within the ₹2.5 lakh limit ensures full tax exemption on ULIP maturity, even if gains are high.

Example 3:

This example illustrates how ULIP maturity proceeds are taxed if the annual premium is above ₹2.5 lakh, making Section 10(10D)* exemption inapplicable.

Tax Treatment:

Section 10(10D)* exemption is not available as the annual premium exceeds ₹2.5 lakh.

Capital gains: ₹65 lakh – ₹60 lakh = ₹5 lakh

LTCG up to ₹1.25 lakh is exempt → Taxable LTCG = ₹3.75 lakh

LTCG tax @12.5% = ₹46,875

Insight: High annual premiums make ULIP maturity proceeds taxable as capital gains.

Conclusion

ULIPs have the advantage of market-linked investment growth and protection of life insurance.  Hence, they are a useful financial instrument, ensuring security to the investor. ULIPs provide three tax benefits: you can deduct premiums under Section 80C*, enjoy tax-free maturity proceeds under Section 10(10D)*, provided annual premiums remain within ₹2.5 lakh (for post-1 Feb 2021 policies), and receive fully exempt death benefits.

Understanding these rules helps you avoid unwanted taxes and strategically plan premiums for maximum exemptions. Therefore, investors can effectively accumulate wealth through ULIPs and save taxes substantially by planning.

FAQs on Ulip Taxation

1. Are ULIP premiums tax-deductible?

Yes, premiums paid on ULIP can be claimed as deduction - under Section 80C* of the Income Tax Act, 1961 to the extent of ₹1.5 lakh annually subject to satisfaction of other conditions. The deduction shall be limited to 10% of the sum assured in case of policies purchased on or after 1st April, 2012.

2. Is income from ULIP taxable at the time of maturity or surrender?

ULIP policies issued on or after 01-02-2021 shall be exempt under Section 10(10D)* if the below conditions are satisfied – 

• The premium paid is not in excess of 10% of the actual capital sum assured (i.e. death sum assured) throughout the policy term.  

• If the premium payable for any year during the term of policy does not exceeds INR 2.5 lakhs and

• Aggregate annual premium should not exceed Rs. 2.5 lakh for all policies held by the policyholder with all life insurers for policies issued on or after February 1, 2021

If any of the above conditions are not satisfied then the policy shall be treated as Section 10(10D) non-compliant and the proceeds shall be taxable.

3. Is the maturity amount from ULIPs taxable?

If a ULIP is not compliant under Section 10(10D)* then at the time of maturity or surrender, LTCG from any ULIP will be taxable @ 12.5%, under the head "Income from Capital Gains”, an exemption of LTCG upto Rs 1.25 lac shall also be available annually.

4. If held more than two ULIPs at a time, how the Taxation will work on maturity or surrender?

When holding two or more ULIPs simultaneously, the benefit shall be available for such policies where the annual premium paid does not exceed ₹2.5 lakh in any financial year. For ULIPs issued on or after 1st February 2021, if the combined premium from all such policies exceeds ₹2.5 lakh in a financial year, the maturity proceeds from the policies crossing the limit become taxable as Long-Term Capital Gains (LTCG). LTCG is taxed at 12.5% without indexation, after allowing an annual exemption of ₹1.25 lakh under Section 112A.

For example, if Mr. Raj holds three ULIPs issued after 01-Feb-2021 with premiums of ₹1,00,000, ₹1,40,000, and ₹1,80,000 in FY 2024-25, he can choose any two policies within the ₹2.5 lakh limit—say, ₹1,00,000 and ₹1,40,000—for claiming Section 10(10D)* exemption. The third policy, exceeding the limit, will be taxable as Long-Term Capital Gains. As clarified in CBDT Circular, the choice of which ULIPs to claim the exemption is entirely up to the taxpayer.

5. What is the lock-in period for ULIP?

ULIPs have a lock-in period of five years from the policy’s commencement date. All such withdrawals or surrenders post the completion of that period will be taxable if Section 10(10D)* conditions are not met. What is the switch option?

ULIPs enable investors to move between equity, debt, or balanced funds under the policy. These fund transfers are completely tax-free, allowing investors to adjust their asset allocation without incurring capital gains tax, which would otherwise be taxable.

6. Is ULIP taxable above 2.5 lakhs?

Yes, if the aggregate premium for all ULIPs exceeds ₹2.5 lakh during any policy year for policies bought on or after 1st Feb, 2021, then the maturity proceeds are taxable. Gains of over ₹1.25 lakh are taxed as long-term capital gains at 12.5% under Section 112A without Indexation.