Union Budget 2025: Simplifying ULIP Income Redemption
Bringing Clarity in Income on Redemption of Unit Linked Insurance Policies (ULIPs)
Unit Linked Insurance Policies (ULIPs) are a hybrid financial product that combines insurance coverage with market-linked investment opportunities. Traditionally, they enjoyed tax exemptions under Section 10(10D) of the Income Tax Act, 1961. However, recent amendments have introduced significant changes in the taxation of ULIPs, especially for high-premium policies.
This blog aims to provide an analytical breakdown of these changes, their tax implications, and practical examples to help investors navigate the evolving taxation landscape of ULIPs.
Understanding Section 10(10D) and the Conditions for Tax Exemption
What is Section 10(10D)?
Section 10(10D) provides an exemption for the maturity proceeds of life insurance policies, including any bonuses, subject to specific conditions:
• The annual premium payable for any policy year should not exceed 10% of the actual capital sum assured.
• If this condition is met, the maturity proceeds remain tax-free in the hands of the policyholder.
Key Changes Introduced by the Finance Act, 2021
To curb tax benefits for high-premium ULIPs, the Finance Act, 2021, introduced the following restrictions:
- Exemption Removal for High-Premium ULIPs
• For ULIPs issued on or after February 1, 2021, if the annual premium exceeds ₹2,50,000, the maturity proceeds are no longer exempt under Section 10(10D).
• This threshold applies to the aggregate premium of all ULIPs held by an individual. - Capital Gains Tax Treatment for ULIPs
• If a ULIP does not qualify for exemption under Section 10(10D), it is now treated as a capital asset under the Income Tax Act.
• Gains from such ULIPs are taxed as capital gains, rather than being fully tax-free. - Tax Treatment for Non-ULIP Life Insurance Policies
• If a non-ULIP life insurance policy does not qualify for exemption under Section 10(10D), the maturity proceeds are taxed under “Income from Other Sources” rather than capital gains.
Revised Taxation Structure for ULIPs
Recent amendments have further refined the taxation of ULIPs, aligning them with equity-oriented funds but with new capital gains tax rates effective from April 1, 2026:
- Classification as a Capital Asset (Section 2(14))
• High-premium ULIPs (where Section 10(10D) does not apply) are considered capital assets, similar to mutual funds. - Taxation of Gains on ULIP Redemption (Section 45(1B))
• If the exemption under Section 10(10D) does not apply, the gains from ULIP redemption are taxed as capital gains.
• New Capital Gains Tax Rates:
• Long-term capital gains (LTCG) (holding period more than 12 months):
• Exempt up to ₹1.25 lakh per financial year.
• Taxable at 12.5% on gains exceeding ₹1.25 lakh.
• Short-term capital gains (STCG) (holding period less than 12 months):
• Taxable at 20%. - ULIPs Treated as Equity-Oriented Funds (Section 112A Explanation Clause (a))
• ULIPs that lose exemption under Section 10(10D) are now classified as equity-oriented funds.
• This ensures taxation rules are aligned with mutual funds.
Effective Date of These Amendments
These changes will come into effect from April 1, 2026, and will apply to the assessment year 2026-27 and subsequent years.
Illustrative Examples of ULIP Taxation
Example 1: Tax-Free ULIP Maturity (Exempt Under Section 10(10D))
• Policyholder: Raj
• ULIP Issued: 2020
• Annual Premium: ₹2,00,000
• Sum Assured: ₹25,00,000
• Maturity Amount: ₹40,00,000
• Tax Treatment: Since the premium is below ₹2,50,000 and the policy was issued before February 1, 2021, the maturity proceeds remain tax-free under Section 10(10D).
Example 2: Taxable ULIP Maturity as Long-Term Capital Gains
• Policyholder: Priya
• ULIP Issued: 2022
• Annual Premium: ₹3,00,000
• Sum Assured: ₹30,00,000
• Maturity Amount: ₹50,00,000
• Holding Period: 5 years
• Tax Treatment:
• Since the premium exceeds ₹2,50,000 and the policy was issued after February 1, 2021, the maturity proceeds are taxed as capital gains.
• Total LTCG = ₹50,00,000 – ₹15,00,000 (Invested Amount) = ₹35,00,000
• Exempt LTCG up to ₹1.25 lakh → Taxable LTCG = ₹33,75,000
• Tax at 12.5% on ₹33,75,000 = ₹4,21,875
Example 3: Taxable ULIP Maturity as Short-Term Capital Gains
• Policyholder: Meera
• ULIP Issued: May 2024
• Annual Premium: ₹4,00,000
• Sum Assured: ₹40,00,000
• Maturity Amount: ₹55,00,000
• Holding Period: 10 months
• Investment Amount (Premium Paid): ₹10,00,000
Tax Calculation:
• Total STCG = Maturity Amount – Investment Amount
= ₹55,00,000 – ₹10,00,000
= ₹45,00,000
• Short-Term Capital Gains Tax at 20%:
= ₹45,00,000 × 20%
= ₹9,00,000
Final Tax Liability: Meera has to pay ₹9,00,000 as short-term capital gains tax on her ULIP maturity proceeds.
Key Learning: Since the ULIP was held for less than 12 months, it is classified as short-term capital gains and taxed at 20%, making early redemption of ULIPs less tax-efficient.
Example 4: Taxable Non-ULIP Life Insurance Policy
• Policyholder: Sameer
• Policy Type: Traditional Endowment Plan (Non-ULIP)
• Annual Premium: ₹3,50,000
• Sum Assured: ₹20,00,000
• Maturity Amount: ₹35,00,000
• Tax Treatment:
• Since the premium exceeds 10% of the sum assured, the maturity amount is taxable.
• Taxed under “Income from Other Sources” at applicable slab rates.
Key Takeaways for Investors
1. Monitor ULIP Premium Limits:
• To qualify for tax-free maturity proceeds, ensure that your total ULIP premium does not exceed ₹2,50,000 per year.
2. Understand Capital Gains Tax on High-Premium ULIPs:
• If your ULIP falls outside Section 10(10D), plan for capital gains tax at 12.5% (LTCG) or 20% (STCG).
3. Compare ULIPs with Other Investment Options:
• Equity mutual funds might offer better post-tax returns compared to ULIPs taxed as capital gains.
4. Diversify for Tax Efficiency:
• Consider a mix of ULIPs, mutual funds, PPF, and term insurance to balance tax benefits and investment growth.
Conclusion
The revised taxation rules for ULIPs aim to bring parity between insurance-linked investments and traditional market investments. While ULIPs remain a compelling choice for tax-conscious investors, those exceeding the ₹2,50,000 premium threshold must now factor in capital gains tax.
Investors should carefully assess their ULIP premiums, expected returns, and tax implications before investing. Seeking professional tax advice can help in making informed investment decisions.
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