Unit-linked insurance plans (ULIPs) provide the dual benefits of life cover and market-linked returns and have been very attractive among conservative investors. However, in the Union Budget 2025, there are some changes in the tax on ULIP withdrawals that every investor should know about. This post will discuss everything you need to know about taxation on ULIPs.
What Was the Tax Rule Before?
Before we get into what is new, it is important to look at the past structure. Since February 1, 2021, ULIP plans with annual premiums over Rs 2.5 lakh saw a 12.5% long-term capital gains (LTCG) tax on withdrawal after one year. This applied only if the total premium paid for one or more policies crossed the Rs 2.5 lakh threshold.
Moreover, in the past, there was a tax that varied based on the type of policy:
- If your ULIP premium was less than Rs 2.5 lakh and your policy also followed the 10% cap relative to the sum assured, your gains were not taxed under capital gains.
- However, if those conditions did not apply, your gains were taxed under “Income from Other Sources” instead of “Capital Gains”.
Confusing? Of course, it was. The rules changed based on how much you invested and how the policy was structured. That is why Budget 2025 came with a simpler and more uniform framework. After the Budget 2025, many investors who did not even know what is ULIP, started investing in them.
What’s New in Budget 2025?
In the latest Finance Bill, a key change has been made to put in place a more consistent and clear tax structure. Going forward:
- Any ULIP policy that does not fall under the exemption of Section 10(10D) will now be taxed under “Capital Gains” – no exceptions.
That’s right. Whether you crossed the Rs 2.5 lakh premium mark or failed to meet the death benefit threshold, your earnings will now be taxed under the Capital Gains category if your policy does not qualify for that tax-free status.
This change is seen as a rational move. It removes the ambiguity of whether the income should be put under “Other Sources” or “Capital Gains”. Moreover, it helps in uniformity and clarity for other investment products that offer similar returns, like mutual funds.
Good News for Small-Ticket ULIP Holders
In Budget 2025, it was announced that if you have invested in a ULIP with annual premiums less than Rs 2.5 lakh and held it for over a year, you will now see tax at 12.5% under Section 112A of the Income Tax Act. And here’s the best part:
- You get an exemption on LTCG up to Rs 1.25 lakh per fiscal year.
This is a welcome relief. This means you can still see a good tax-free gain from your ULIP investment before the taxman comes after you. What this does is it makes ULIPs more attractive for middle-class investors who wish to save and invest without crossing that Rs 2.5 lakh premium mark.
What Does This Means For You?
If you are a present ULIP holder or are to invest in one, here is how the new rules play out for you:
- Do you have a ULIP with a premium of over Rs 2.5 lakh annually? You’ll still be taxed at 12.5% on gains, as before. But now it is officially put under Capital Gains, not “Other Income”.
- Holding a ULIP with a lower premium? Your gains will be taxed the same way, but with the added benefit of the Rs 1.25 lakh LTCG exemption.
- Are you thinking of switching to or investing in ULIPs? These changes make it a must to assess your investment goals. If tax efficiency is a key factor, see to it that your premiums stay under the exemption limit.
What Should ULIP Investors Do Presently?
If you are a present ULIP investor, here is what you may want to think about:
- Go over your policy premium and see what qualifies for Section 10 (10D) exemption.
- Calculate your long-term capital gains and what that does against the 1.25 lakh exemption.
- If you are into ULIPs only for tax benefits, maybe it’s time to reevaluate your approach – options like ELSS funds or PPF may present better tax efficiency.
- For new investors, do not let the tax change dissuade you. While the tax play has changed, ULIPs still present a great mix of insurance and investment, which may be very appropriate for certain long-term goals.
Final Thoughts
In Budget 2025, we see the introduction of a much-simplified tax structure that brings much-needed clarity for investors. Though this may put a bit of a dent in the appeal of high-value ULIPs as tax-saving instruments, it does bring about a fairer playing field when compared to other investment products like equity mutual funds.
ULIPs still have a place in the market for what they offer in terms of a mix of insurance and investment. With smart tax planning and awareness of these new rules, you can still get the most out of your ULIP investments without getting into tax issues.
