Planning for the future in an Indian household often revolves around the idea of securing the family while letting one’s hard-earned money grow. Hybrid financial products that strike a balance between safety and growth have long been a favourite among investors. ULIPs have seen a significant rise in popularity across the country because they strike a perfect balance between life insurance and investment. But how much do you know about a ULIP plan beyond its basics? One’s knowledge of ULIP taxation is equally important as its features. Tax laws can be confusing, but there is no need for them to be complicated in your day-to-day life. Be it a metro city or a small town, everyone must understand the fundamentals and implications of ULIP taxation if they want to secure their families’ future.
What Is a Unit Linked Insurance Plan?
A Unit Linked Insurance Plan is a financial contract between you and an insurance company, wherein a part of your premium is utilised to buy units in various investment funds. A ULIP plan’s primary appeal lies in its flexibility and control over your investments. When it comes to ULIPs, you have three basic options at your disposal:
- Life Cover: A part of your premium goes into a life cover and pays out to your nominee in the event of your demise
- Market Investment: The remainder of the premium is open to you to invest in funds. Choose from equity, debt, or balanced funds based on your risk appetite
- Volatility: Since money is invested in financial markets, it is bound to fluctuate
It must be noted that the lock-in period for a ULIP is mandatory. As per the legal guidelines, these insurance products come with a 5-year lock-in period.
You cannot withdraw from a ULIP scheme anytime before the 5 years are up.
Deductions Under the Income Tax Act, 2025
When it comes to ULIP taxation, there are provisions for tax deductions under the Income Tax Act, 2025.
Section 123 (read with Schedule XV) of the Income Tax Act, 2025, permits a deduction in the computation of income from life insurance business for the amount of premium paid. The deduction is limited to Rs. 1.5 lakhs in a given financial year, which is shared with eligible deductions under section 123.
This is generally true for those who opt for the old tax regime, however, the deduction might not be available for those who opt for the new tax regime.
Your yearly premium must not exceed a certain percentage of the sum assured, which is typically 10% for new policies, and must be determined by the insurer.
Fund Switching
The beauty of a ULIP is that it allows you to switch between funds as and when you deem fit, without having to pay any tax on the profit earned. The ability to switch funds lets you mitigate some of the risks of market volatility.
Investors who switch their money from equity to debt funds or vice versa do not have to pay any capital gains tax at the time of switching. Investors do not have to pay tax on the profits made on a ULIP while it is in the fund wrapper.
Taxation On Maturity And Partial Withdrawal
The lump sum amount that a policyholder receives upon maturity is subject to taxation as well.
As far as ULIP taxation is concerned, the amount received on maturity is tax-free if the total yearly premium for all policies does not exceed Rs. 2.5 lakhs as per section 11 (read with Schedule II) of the Income Tax Act, 2025 in the year of maturity. If an investor’s yearly premium exceeds two lakhs, then the maturity proceeds will no longer be tax-free and will instead be subject to capital gains tax.
The same provision applies to partial withdrawals. In the year of withdrawal, if the aggregate amount withdrawn does not exceed Rs. 2.5 lakhs, it will not be subject to taxation. If the total amount withdrawn exceeds this threshold, then it will be taxed according to the applicable capital gains tax.
Taxation On Death During the Policy Term
The fundamental goal of a financial arrangement in an Indian household is to protect the family in case of an unfortunate event. Any amount paid to the nominee of the policyholder upon their demise is entirely tax-free.
The tax exemption on death proceeds is consistent throughout various slabs and sections of the Income Tax Act, 2025.
While the Income Tax Act, 2025 has provisions for tax exemptions for lump sum maturity proceeds and partial withdrawals, the tax exemptions on death proceeds are entirely devoid of any restrictions.
Tax Consequences Of A ULIP Surrendered Before the 5-Year Lock-In Period
Life is full of surprises and sometimes people might have to exit out of a financial product midway due to certain personal reasons. A ULIP surrendered before the 5 years are up attracts certain tax consequences.
Any amount surrendered before the 5 years are up is transferred to a discontinuance fund until the 5 years are up. Any tax deducted under section 123 to arrive at the tax-free amount will be reversed and added back to your income in that financial year. The surrender proceeds would only be released to the policyholder after the 5 years are up and will be subjected to taxation as per the applicable capital gains tax.
Things To Keep In Mind
Every taxpayer has a unique set of circumstances. Tax laws are subject to change from time to time and the slabs for applicable income tax also vary for different streams of income. It is always advised to go through all the documents thoroughly before purchasing any financial product. Pay close attention to the expenses part of theULIP document since it mentions the various taxes applicable to the funds, such as Goods and Services Tax (GST), that are applicable to insurance contracts. It is always better to consult a tax expert or a professional financial planner to help you decide the best possible course of action for your family’s future financial needs in light of the various provisions under the Income Tax Act, 2025. Since the terms and conditions for tax deduction, eligibility, and underwriting differ from insurer to insurer, a customised approach is the best way to go.
