Have lost their tax edge: Expert sounds the alarm on ULIPs

India Today

08-07-2025

For years, Unit Linked Insurance Plans (ULIPs) were sold as the ideal financial product, offering insurance, market-linked returns, and tax-free maturity benefits. But recent changes to tax laws have reshaped the picture in ways many investors are still catching up with. According to tax expert Sujit Bangar, ULIPs no longer offer the sweeping exemptions they once did, especially for those paying higher premiums.advertisementUnder Section 80C of the Income Tax Act, ULIP premiums are eligible for deductions up to Rs 1.5 lakh a year. But that deduction is conditional. It's allowed only if the annual premium doesn't exceed 10% of the sum assured, for policies issued after April 1, 2012. And the policy must be held for at least five years—otherwise, the deduction is reversed. 'Policy must not be surrendered within 5 years,' Bangar cautions.The bigger change, though, came in Budget 2021. ULIP maturity proceeds, which were previously tax-free across the board, are now taxable if annual premiums exceed Rs 2.5 lakh. This applies to all ULIP policies issued on or after February 1, 2021. And the threshold isn't per policy, it's cumulative. If the total premium paid across all ULIPs crosses Rs 2.5 lakh, the tax exemption is gone. 'ULIP maturity proceeds are tax-free only if annual premium Rs 2.5L,' says Bangar.
For those who breach this threshold, the tax treatment begins to resemble that of mutual funds. Gains from ULIPs held for more than 12 months are taxed as long-term capital gains at 12.5%, but only on the amount exceeding Rs 1,25,000. If the holding period is shorter, the gains are taxed at 20% as short-term capital gains. The old assumption that ULIPs always offer tax-free returns no longer holds.Even fund switches within ULIPs, which were once exempt from tax, are now taxable events if the policy exceeds the premium limit. If the ULIP doesn't qualify for Section 10(10D) exemption, any switch between equity and debt is treated like a withdrawal. 'Tax-free if ULIP qualifies for Sec 10(10D),' Bangar notes. 'Taxable as redemptions if it doesn't.'One area that remains untouched is the death benefit. The amount received by a nominee upon the policyholder's death is fully exempt under Section 10(10D), regardless of how much was paid in premiums. 'No premium cap applies here,' Bangar affirms.There's also a warning for early exits. If a ULIP is surrendered within five years, the tax deduction claimed under Section 80C is withdrawn and the entire surrender value is added to the policyholder's income. This can mean a significant tax hit if not accounted for in advance.advertisementThe motivation behind these changes, Bangar explains, was to close a loophole that allowed high-net-worth individuals to gain tax-free equity exposure through insurance routes. 'ULIPs with premium > Rs 2.5L/year are taxed like mutual funds,' he points out. Before Budget 2021, all maturity proceeds from ULIPs were tax-exempt. After the changes, the playing field was levelled.The result is that ULIPs have lost much of their appeal as tax-saving instruments, especially for those paying large premiums. Bangar offers a clear comparison: mutual funds are now more transparent, more flexible, and more cost-effective. 'ULIPs lost their tax edge at higher premiums. Mutual funds are more transparent & cost-effective,' he says. That leaves ULIPs best suited for those looking for long-term insurance and forced savings, rather than aggressive tax planning. 'Choose ULIPs only if insurance + forced savings is your priority.'As investors weigh their options, it's worth remembering that the tax benefits of a ULIP can quietly slip away with just a few extra rupees in annual premiums. What once looked like a dual-purpose product—offering safety and returns—now comes with more fine print than ever. And for many, the promise of tax-free income may end up being an illusion.advertisement(Disclaimer: This article is for general informational purposes only and does not constitute financial advice. Readers are encouraged to consult a certified financial advisor before making any investment or financial decisions. The views expressed are independent and do not reflect the official position of the India Today Group.)- Ends