Taxability of ULIP: Navigating the Tax Labyrinth of ULIPs: A Detailed 2024-25 Report

Investment Stage: Deduction under Section 80C

Investing in a ULIP continues to offer tax benefits at the initial stage. The premiums paid towards a ULIP are eligible for a deduction from your gross total income under Section 80C of the Income Tax Act, 1961. The maximum deduction under this section is capped at ₹1.5 lakh per financial year.

However, a crucial condition must be met to avail this benefit: the annual premium should not exceed 10% of the sum assured for policies issued on or after April 1, 2012. For policies issued before this date, the limit is 20% of the sum assured. If the premium exceeds this prescribed limit, the deduction under Section 80C will be proportionately disallowed.

Maturity Proceeds: The Bifurcation Point

The tax treatment of maturity proceeds from a ULIP is where the rules have seen a significant overhaul, primarily due to the amendments introduced in the Union Budget 2021. The taxability now hinges on the date of policy issuance and the aggregate annual premium.

Policies Issued on or after February 1, 2021:

For ULIPs issued on or after this date, the taxability of maturity proceeds is determined by the aggregate annual premium paid by the policyholder.

• Low-Premium ULIPs (Annual Premium up to ₹2.5 lakh): If the aggregate annual premium paid for all ULIP policies taken by an individual is up to ₹2.5 lakh, the maturity proceeds, including any bonus, are exempt from tax under Section 10(10D) of the Income Tax Act. The condition that the annual premium does not exceed 10% of the sum assured must also be satisfied.

• High-Premium ULIPs (Annual Premium exceeding ₹2.5 lakh): If the aggregate annual premium for all ULIPs held by an individual exceeds ₹2.5 lakh in any financial year during the policy term, the maturity proceeds will be treated as capital gains and taxed accordingly.

  • If the ULIP is predominantly equity-oriented (at least 65% of its portfolio in domestic equities), the gains will be taxed as Long-Term Capital Gains (LTCG) at 10% (plus applicable surcharge and cess) on the gains exceeding ₹1 lakh. No indexation benefit is available.

  • If the ULIP is predominantly debt-oriented, the gains will be taxed as per the investor's applicable income tax slab rates.

Policies Issued before February 1, 2021:

For ULIPs issued before this date, the old tax regime continues to apply. The maturity proceeds are fully exempt from tax under Section 10(10D), provided the annual premium paid does not exceed 10% of the sum assured (20% for policies issued before April 1, 2012). The ₹2.5 lakh premium threshold is not applicable to these policies.

Premature Withdrawal (Surrender) of ULIP

The tax implications of prematurely withdrawing or surrendering a ULIP depend on the lock-in period of five years.

• Withdrawal within the 5-year lock-in period: If a ULIP is surrendered before the completion of the five-year lock-in period, the entire surrender value will be considered as income for that financial year and will be taxed as per the individual's applicable income tax slab rates. Furthermore, any tax deductions claimed under Section 80C in the previous years on the premiums paid will be reversed and added to the income of the year of surrender.

• Withdrawal after the 5-year lock-in period: If the ULIP is surrendered after the completion of the five-year lock-in period, the tax treatment will be the same as that of maturity proceeds, as explained above. For policies issued on or after February 1, 2021, if the annual premium exceeds ₹2.5 lakh, the surrender value will be subject to capital gains tax. For other policies, the surrender value will be tax-exempt under Section 10(10D), subject to the premium-to-sum-assured ratio.

Death Benefit

In the unfortunate event of the policyholder's demise, the death benefit received by the nominee is completely tax-free under Section 10(10D) of the Income Tax Act. This exemption applies irrespective of the premium amount or the date of policy issuance.

Partial Withdrawals

ULIPs allow for partial withdrawals after the completion of the five-year lock-in period. The taxability of such withdrawals depends on the overall tax treatment of the policy:

• If the maturity proceeds of the ULIP are tax-exempt under Section 10(10D) (i.e., for policies issued before February 1, 2021, and low-premium policies issued thereafter), any partial withdrawals are also tax-free.

• For high-premium ULIPs (issued on or after February 1, 2021, with an annual premium exceeding ₹2.5 lakh), where the maturity proceeds are taxable as capital gains, partial withdrawals will also be subject to capital gains tax. The gains will be calculated on a proportionate basis.

Fund Switching

One of the key advantages of a ULIP is the flexibility to switch between different fund options (equity, debt, or balanced) within the plan. Importantly, fund switching within a ULIP is not considered a transfer and is therefore not subject to any tax. This allows investors to manage their portfolio according to market conditions and their risk appetite without any immediate tax consequences.

ULIP Taxability Summary (FY 2024-25)

In conclusion, while ULIPs continue to offer tax benefits on investment, the taxation of maturity and withdrawal proceeds has become more nuanced. Investors, especially those considering high-premium policies, need to be aware of the capital gains tax implications introduced by the Budget 2021 amendments. For all ULIP investors, understanding the conditions under Section 80C and Section 10(10D) is crucial to effectively plan their investments and tax liabilities.