How ULIPs Will Be Taxed After the Union Budget 2025-26

Many investors are also allured with this idea of getting two birds with one stone -- insurance and investments -- while ideally insurance and investment needs must be dealt with separately. One of the reasons for this is Unit Linked Insurance Plans or ULIPs being revamped (with an array of fund choices available for investment across asset classes with flexibility), continued buoyancy in the Indian equity market, and many retail investors participating.

Recognising this, in the Union Budget 2025-26 Finance Minister, Ms Nirmala Sitharaman, has made certain changes in the way ULIPs will be taxed on redemption of units.

It is now proposed and clarified in the Union Budget 2025-26 that the profit and gains from the redemption of ULIPs to which exemption under Section 10(10D) of the Income Tax Act, 1961 does not apply, shall be charged to tax as capital gains.

In other words, ULIP will now be considered as a Capital Asset.

To rationalise the provisions for unit-linked insurance policies, the memorandum to the Union Budget 2025 has provided that:

• ULIPs to which exemption under clause (10D) of section 10 does not apply, is a capital asset [clause (14) of section 2];

• The profit and gains from the redemption of ULIPs to which exemption under clause (10D) of section 10 does not apply, shall be charged to tax as capital gains [sub-section (1B) of section 45]; and

• ULIPs to which exemption under clause (10D) of section 10 does not apply, shall be included in the definition of equity-oriented fund [clause (a) of Explanation to section 112A]

It should be noted that the payouts from life insurance products, including bonuses, are tax tax-exempt under Section 10(10D) only when certain conditions are met:

• The policy is purchased on or after April 1, 2012; and

• The premium paid on the policy does not exceed 10% of the Sum Assured (SA) in any year during the policy term;

• In respect of ULIPs issued after February 1, 2021, the total premium paid in any year does not exceed Rs 2.50 lakh

Note, that these conditions are applicable only if the policy is not surrendered or terminated during the policy term.

If these conditions are met, exemption under Section 10(10D) can be availed, thus enhancing the tax savings.

If the exemption under Section 10(10D) does not apply, then the sum received from a ULIP will now with taxed as a Capital Gain (treating it as a Capital Asset).

That is to say, ULIPs will now be on par with equity-oriented mutual funds wherein, typically the long-term gains will be taxed at 12.5% without indexation benefit with effect from April 1, 2025 (applicable to Assessment Year 2026-27, relevant to FY 2025-26). Keep in mind, that the 12.5% LTCG tax applies only when the profits and gains exceed Rs 1.25 lakh in a financial year.

In the case of a switch from one type of fund to another, since the sum of money is not received by the insured/investor per se, there is will no tax implications which is unlike for mutual funds.

The new proposal made in the Union Budget 2025-26 will indirectly benefit investors, as earlier by not treating ULIPs as a Capital Asset, the sum received from a ULIP was taxed as per the income-tax slab rate, i.e. at the marginal rate of taxation. Now by treating ULIP as a 'Capital Asset' as per its definition under the Income Tax Act, the Modi-led-NDA government has taken a welcome and progressive step. It has removed whatever ambiguity existed as regards tax implications on the redemption of ULIPs.

Those opting for the Old Tax Regime (which is not the default tax regime), can still avail of a deduction under Section 80C of up to Rs 1.50 lakh in the financial year when paying the insurance premium.

Should You Opt for ULIPs?

As far as possible you should not commingle your insurance and investment needs. Doing so helps maintain clarity and efficiency.

The 5-year lock-in period in the case of ULIPs (which highlights poor liquidity), higher premium allocation charges, high fund management fee levied, and policy administration charges are rather discouraging facets of ULIPs.

Despite this, ULIPs are aggressively marketed and mis-sold. Against the cost or premium paid to buy a ULIP, the Sum Assured is not sufficient considering one's Human Life Value. Compared to mutual funds, ULIPs are complex and are far less transparent.

It is best to approach insurance and investments separately, as they serve distinct purposes. For life insurance needs, buying a pure term insurance plan without the investment component involved, serves the objective of protection of risk with a better cost-to-benefit (i.e. keeps premium relatively low and offers a higher Sum Assured).

For investment, where making inflation-beating returns or wealth creation is often the objective, a carefully crafted portfolio of some of the best and most suitable mutual fund schemes and other investment avenues considering your risk profile, the financial goal/s you are addressing, and time horizon, keeping asset allocation in mind, is a preferable option.

It is important to be thoughtful in your approach.

Happy Investing!

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Disclaimer: Investment in securities market are subject to market risks, read all the related documents carefully before investing.

This article is for information purposes only and is not meant to influence your investment decisions. It should not be treated as a mutual fund recommendation or advice to make an investment decision in the above-mentioned schemes.