The Union Budget 2025 has significantly clarified the tax treatment of Unit-Linked Insurance Policies (ULIPs). ULIPs that do not qualify for tax exemptions under Section 10(10D) of the Income Tax Act have so far lacked clarity on how they will be taxed. The latest budget has laid out specific guidelines on the taxability of the maturity proceeds, death benefits, and partial withdrawals from non-qualifying ULIPs.
The key changes provide much-needed transparency on the applicable tax rates and calculation methodology for these three components of non-exempt ULIPs. This will enable insurers, distributors and policyholders to accurately determine the post-tax returns from this commonly used insurance-cum-investment product. The changes will also help rationalise ULIP charges and align product designs to optimise returns for policyholders within the clarified tax framework.
What do you mean by ULIPs?
A Unit Linked Insurance Plan or ULIP combines insurance protection and investment in one plan. In a ULIP, part of the money you pay as a premium is used to provide life insurance coverage from an insurance company. The remaining portion of the premium is invested in funds such as stocks, bonds, or both, as you choose.
The goal of ULIP is to meet your long-term financial needs, such as retirement planning or children’s education, while also providing insurance protection. You can choose a ULIP fund option that aligns with the timeline of your financial goal so that your money can potentially grow over time. The invested portion accumulates wealth, which helps meet your future needs. At the same time, your family is protected with the insurance cover in case of uncertainties.
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How Does ULIP Work?
When you purchase a Unit Linked Insurance Plan (ULIP), part of your premium amount goes towards securing a life cover from the insurance provider. Fund managers invest the remaining portion in investment options like stocks and bonds, as you choose. You are freed from having to actively track or manage these investments.
A key benefit of ULIPs is that you can switch your investment between equity and debt funds based on your risk tolerance and reading of the market outlook. For instance, when stock markets seem risky, you can instruct your ULIP fund manager to move more of your money into less volatile debt funds. Similarly, you can take higher exposure to equities when markets seem favourable. The flexibility to change asset allocation simply makes ULIPs an attractive investment-cum-insurance instrument for many.
Lock-in Period of ULIP
Unit-linked insurance plans usually have a minimum lock-in period of 5 years. This means your money will remain invested in the ULIP for at least 5 years before you can make withdrawals or surrender the policy. However, financial experts often recommend holding your investments for longer than the lock-in, possibly 7-10 years, to allow better growth potential.
Decisions regarding discontinuing or continuing ULIPs after the lock-in should be taken only after consulting a registered investment advisor. They can review your unique needs, risk appetite, and market conditions before suggesting suitable actions for your ULIP investments.
Key Changes in Budget 2025 Related to ULIPs
The Union Budget 2025 has clarified the taxation of Unit-Linked Insurance Plans (ULIPs). ULIPs with an annual premium exceeding Rs 2.5 lakhs will now be treated as capital assets for tax purposes. This means that the same tax rules will apply to these policies as those applicable to investments in equity mutual funds.
Simply put, the maturity amount, withdrawal amounts, or bonuses from such ULIPs over Rs 2.5 lakh annual premium will be considered capital gains and taxed accordingly. This change aligns the tax treatment of high-value ULIPs with other comparable market-linked investment products.
Impact on Taxation of ULIPs
| Criteria | Previous Tax Treatment | New Tax Treatment (Budget 2025) |
|---|---|---|
| Annual premium ≤ Rs 2.5 lakh | Exempt under Section 10(10D) | Exempt under Section 10(10D) |
| Annual premium > Rs 2.5 lakh | Taxability was unclear | Treated as capital assets, taxed as equity funds |
| LTCG on gains > Rs 1.25 lakh | Not applicable | Taxed at 12.5% |
| STCG (Holding period < 12 months) | Not applicable | Taxed at 20% |
Note: The new tax rules make high-premium ULIPs more tax-efficient. Now, maturity and withdrawal amounts above Rs 2.5 lakh annual premium will attract 12.5% long-term capital gains tax. This is beneficial compared to the earlier taxation as per income slab rates under another income category.
Understanding Section 10(10D) and its Conditions
Section 10(10D) of the Income Tax Act grants tax exemption on maturity or death benefits from life insurance policies (including ULIPs) subject to certain limits:
- To avail of the tax exemption benefit, the annual insurance premium paid for standard term and endowment policies issued after 1 April 2012 should not exceed 10% of the assured sum.
- For Unit-Linked Insurance Plans (ULIPs) bought after 1 February 2021, the Total premium paid per year should not exceed Rs 2.5 lakhs for policy proceeds to remain tax-free.
- For traditional endowment policies starting 1 April 2023, the annual premium limit for availing tax-free status on maturity amount is capped at Rs 5 lakhs.
As per budget 2025, section 10(10D) sets clear thresholds on premium amounts to determine which policy proceeds will be taxed. Anything above the said premium limits will be taxed as per applicable capital gains or income tax rules. Adhering to the premium caps is crucial for gaining full tax benefits on policy maturity or death claim payouts.
Key Takeaways from Budget 2025 for ULIP Policyholders
The Union Budget 2025 has brought much-needed clarity on the taxation of ULIPs. ULIPs with annual premiums over Rs 2.5 lakhs will now be treated as capital assets and taxed like equity mutual funds. The maturity corpus, withdrawals and bonuses from such policies will attract long-term (12.5%) or short-term capital gains tax (20%) based on the holding period. However, ULIPs within the Rs 2.5 lakh annual premium limit remain tax-exempt under Section 10(10D).
The premium caps to be eligible for this exemption are now clearly defined. The changes align the taxation of high-value ULIPs with other market-linked investments while retaining benefits for retail investors. ULIP policyholders must review premiums to optimally structure policies and ensure full tax efficiency.
Author: All Content is verified by SMC Global Securities.
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