Tax on ULIP: Taxation Rules of Unit-Linked Insurance Plan

A Unit Linked Insurance Plan (ULIP) is a combination of life insurance and investment, with part of the premium invested in market-linked funds. ULIPs issued on or after 1st February 2021, maturity proceeds remain tax-free only if the annual premium does not exceed Rs 2.5 Lakh. If the premium exceeds the limit, including across multiple ULIPs, the maturity gains would be taxed as long-term capital gains at 10% on the portion above Rs 1 Lakh. 

A Unit Linked Insurance Plan (ULIP) is a combination of life insurance and investment, with part of the premium invested in market-linked funds. ULIPs issued on or after 1st February 2021, maturity proceeds remain tax-free only if the annual premium does not exceed Rs 2.5 Lakh. If the premium exceeds the limit, including across multiple ULIPs, the maturity gains would be taxed as long-term capital gains at 10% on the portion above Rs 1 Lakh. 

Budget 2025 Update

ULIPs are insurance plans that also act like investments, as part of your premium goes into the stock market.

• Earlier: Only ULIPs with an annual premium above ₹2.5 lakh were considered capital assets.
• New Rule: The changes are made to include ULIPs with premiums exceeding 10% of the policy value as well.
• If your premium is below ₹2.5 lakh per year, the money you get remains tax-free.

Amendment: Finance Tax, 2021 

The Finance Act, 2021, introduced certain provisions through amendments to Section 10(10D) to amend the taxability of ULIP maturity proceeds. Those provisions are applicable from February 1, 2021. 

As per the amendment, the maturity amounts of ULIP plans where policies are issued on or after February 1, 2021, will no longer be exempt, in case: 

• If you have paid a premium over Rs 2.5 lakh for any of the years during the tenure of the ULIP, then the amount received (including the bonus) at the time of maturity will be taxable or
• If you have purchased multiple ULIP plans and the aggregate premium paid exceeds Rs 2.5 lakh, then it is subject to taxation.

Taxability of ULIP

Maturity proceeds on ULIP will be taxable as Long-term capital gains (LTCG) tax like the LTCG tax on all equity-oriented investments.  Also, tax shall be paid (in the case of long-term capital gains (LTCG) at 10%. However, no taxation is imposed if maturity proceeds are received upon the death of an individual. 

In short, ULIP plans are now at par with stocks or equity-oriented mutual funds.

Examples

Let’s look at some practical examples to understand how the taxation rules will apply. (It is assumed that plans have been purchased after the applicability of amendment)

Example-1:

Mr. A and Mr. B purchased ULIP plans with Rs. 15 lakhs and Rs. 35 lakhs, respectively, and a maturity period of 10 years. Mr. A's annual premium is Rs 1,00,000, while Mr. B's is Rs 3,00,000.

After ten years, Mr A receives Rs. 20 lakhs in maturity proceeds, while Mr B receives Rs. 48 lakhs. 

Taxability of Maturity Proceeds -

In the hands of Mr A: As the annual premium was within the limit of Rs. 2.5 lakhs, the maturity proceeds received by Mr A will be tax-free.

In the hands of Mr B: Now, as Mr B's annual premium exceeded Rs 2.5 lakhs during the policy's term, he is liable to pay tax on Rs. 18 lakhs (i.e. Rs 48 lakhs less Rs 30 lakhs) (Maturity proceeds less the aggregate premium paid).

Example-2:

An individual has a ULIP policy with the details mentioned below.

Taxability of Maturity Proceeds -

The consideration received will be exempt under clause (10D) as the annual premium payable on the policy is not more than Rs 2.5 lakh.

Example-3:

An individual had bought ULIP, which satisfies all the conditions mentioned under Section 10(10D). He did not receive any consideration under other eligible ULIPs in earlier financial years preceding 2031-32.  The details are as mentioned in the table:

Taxability of Maturity Proceeds -

As per the law, where premiums are payable for multiple ULIPs, the maturity proceeds of only eligible ULIPs will be exempt (eligible ULIPS are those where the aggregate annual premium did not exceed Rs. 2.5 lakhs for any of the financial years during their term).

Hence, in Example 3, the consideration received under ULIP Z will not be exempt as the aggregate annual premium payable for ULIP X, Y, and Z exceeds Rs 2.5 lakh during the term of these policies.  

The consideration received under ULIPs X and Y will still be exempt, as the aggregate annual premium payable for the two policies did not exceed Rs 2.5 lakh for any financial year during the term of these two policies. 

Example-4:

An individual bought multiple ULIPs; the details are as below.

Taxability of Maturity Proceeds -

The consideration under ULIP A will be exempt as the policy has been issued before February 1, 2021. 

The consideration received under ULIP Z will not be exempt as the aggregate of the annual premium payable for  ULIP X, Y, and Z exceeds Rs 2.5 lakh during the term of these policies.  

The consideration received under ULIPs X and Y will still be exempt, as the aggregate annual premium payable for the two policies did not exceed Rs 2.5 lakh for any financial year during the term of these two policies. 

Conclusion

Why did the government introduce such an amendment? Earlier, under the provisions of ITA, there was no cap on the annual premium paid during the policy term for any person. It was noticed that specific high-net-worth individuals were choosing the ULIP route to earn tax-free returns from the stock markets by diverting their investment through ULIPs rather than doing it directly through investment in shares. Thus, they claimed exemption under this clause by investing in ULIPs with a high premium and receiving completely tax-free maturity proceeds.

Hence, to curb this malpractice of undue utilisation of the ULIP exemption, the maximum premium that can be paid on ULIP policies has been capped.