ULIP Taxation: How Premiums and Maturity Are Taxed

A Unit Linked Insurance Plan (ULIP) is a financial product that integrates investment with life insurance coverage. A portion of the premium is allocated to provide a life cover, while the remaining amount is invested in market-linked instruments like equity or debt funds. This structure allows for wealth creation while maintaining a safety net for beneficiaries. The tax treatment of ULIPs has undergone changes, making it important to understand the regulations governing premium payments and maturity proceeds.

Tax Benefits on Premiums Paid

The tax advantage for paying ULIP premiums is a deduction available under Section 80C of the Income Tax Act. Policyholders can claim a deduction from their gross total income for premiums paid, capped at ₹1,50,000 per year, which is the overall limit for all eligible investments and expenses under this section. This benefit is available to individuals for policies taken for themselves, their spouse, or their children, as well as to a Hindu Undivided Family (HUF) for any of its members.

To qualify for this deduction, the annual premium for ULIPs issued on or after April 1, 2012, cannot exceed 10% of the sum assured. If the premium surpasses this limit, the deduction is restricted to 10% of the sum assured. For policies issued before this date, the threshold was 20%. This framework ensures the product’s primary character as an insurance policy is maintained.

Taxation on Maturity and Withdrawals

The tax treatment of funds from a ULIP is governed by Section 10(10D) of the Income Tax Act, with rules depending on the policy’s issuance date. For policies issued before February 1, 2021, maturity proceeds are tax-exempt. This exemption is contingent upon the annual premium not exceeding 10% of the sum assured. If this condition is satisfied throughout the policy term, the entire amount received by the policyholder, including any bonus, is free from tax.

A shift occurred for ULIPs issued on or after February 1, 2021. For these policies, the tax exemption is withdrawn if the aggregate annual premium paid for one or more such ULIPs exceeds ₹2,50,000 in any financial year. If the premium remains at or below this threshold, the proceeds continue to be tax-exempt, provided the 10% premium-to-sum-assured condition is also met.

Any ULIP that does not qualify for an exemption is treated as a capital asset, and the gains from such policies are taxed as capital gains. The taxable gain is calculated as the difference between the maturity value and the aggregate premiums paid. If the units are held for more than 12 months, the gain is classified as Long-Term Capital Gains (LTCG) and is taxed at a rate of 10% on the amount exceeding ₹1 lakh. If held for 12 months or less, the gain is a Short-Term Capital Gain (STCG), taxed at 15%.

The amount received by a nominee upon the death of the life assured remains fully tax-exempt, irrespective of the premium amount or policy issuance date.

Tax Implications for Specific Situations

The ₹2,50,000 annual premium threshold for policies issued on or after February 1, 2021, requires aggregating premiums from all such ULIPs held by an individual. For instance, if a person holds two new ULIPs with annual premiums of ₹1,50,000 and ₹1,20,000, the total of ₹2,70,000 breaches the limit. The policyholder can choose which policy or policies to claim exemption for, as long as the combined premium of the selected plans does not exceed the limit. The proceeds from the remaining policy would then be subject to capital gains tax.

Surrendering a ULIP before its 5-year lock-in period has tax repercussions. First, any premium payment deductions claimed in previous years are reversed. This means the deducted amounts are added back to the policyholder’s income in the year of surrender and taxed accordingly. Second, the entire surrender value received is treated as “Income from Other Sources” for that financial year and is taxed at the individual’s applicable income tax slab rate.

Switching investments between a ULIP’s different fund options, such as moving from an equity fund to a debt fund, is not considered a taxable transfer. This allows policyholders flexibility to manage their investment portfolio in response to market conditions without an immediate tax liability.