Ulips with annual premiums of over Rs 2.5 lakh to be taxed like equity MFs. Here’s what it means for policyholders

How will high-value Ulips' maturity proceeds be taxed?

Budget 2025 provided much-needed clarity around taxation of redemption or maturity proceeds of unit-linked insurance policies (ULIP) where the aggregate premiums paid during the year exceed Rs 2.5 lakh. Put simply, ULIPs that do not qualify for tax exemption under section 10(10D) will now be treated as equity-oriented mutual funds.

“ULIPs to which exemption under clause (10D) of Section 10 [of the Income-tax Act] does not apply shall be included in the definition of equity-oriented fund,” the memorandum to the budget states. The amendment will come into effect from April 1.

Here’s a lowdown on what this means for holders of such high-value ULIPs, particularly those purchased on or after February 1, 2021.

How will the Budget 2025 amendment on ULIPs affect the taxability of gains made on redemption or maturity?

Put simply, Budget 2025 has clarified that ULIPs where the proceeds received on redemption or maturity are not eligible for exemption under Section 10(10D) will be treated as capital assets. The tax treatment will be similar to that of equity-oriented funds; so profits made on redemption will be treated as capital gains. “If the conditions [of Section 10(10D] are not fulfilled, the sum received under insurance policy may be charged to tax as capital gains (for unit-linked insurance policy) or income from other sources income (for policy other than ULIP),” the income tax (I-T) department’s FAQs say.

Long-term capital gains of over Rs 1.25 lakh a year booked on sale of equities and equity mutual fund units invite a tax of 12.5 percent, while short-term capital gains (holding period of less than 12 months) attract a tax rate of 20 percent. Capital gains tax structures across asset classes were rationalised in Budget 2024.

What is Section 10(10D)?

Under Section 10(10D) of the Income-tax Act, any sum received under a life insurance policy, including bonus on such policy, is exempt from tax. So the amount that policyholders receive at maturity or the claim amount that nominees get upon the policyholder’s death is tax-free.

However, this exemption is subject to conditions. For one, it is not available to redemption or maturity proceeds of life insurance policies where the annual premium exceeds 10 percent of the sum assured.

In addition, proceeds received under ULIPs sold after February 1, 2021 are not eligible for this tax exemption if the aggregate annual premiums paid by the policyholder exceed Rs 2.5 lakh. Further in February 2023, Finance Minister Nirmala Sitharaman decided to withdraw this tax exemption to endowment policies with aggregate annual premiums of over Rs 5 lakh.

“The conditions which are to be fulfilled to claim exemption under Section 10(10D) include: a) premium payable for any of the years during the terms of the policy (life insurance or ULIP) issued on or after April 1, 2012 should not exceed ten per cent of the actual capital sum assured; and b) amount of premium or aggregate amount of premium payable during the term of such policy or policies should not exceed Rs 2.5 lakh (for ULIPs) or Rs 5 lakh (for other policies) for policies issued after certain dates (that is, April 1, 2021 for ULIPs and April 1, 2023 for endowment plans),” as per the I-T department’s FAQs.

Why was the clarification needed?

“In the present provisions, in the case of ULIP, even where the payable premium exceeded 10 percent of the sum assured, the sum received on redemption was not being charged to tax as ‘capital gain’ under sub-section (1B) of Section 45. Even though it was not exempt, there was ambiguity regarding the head of chargeability,” the I-T department has stated.

Chartered accountants Moneycontrol spoke to said they had always considered ULIPs as capital assets. “However, there was disagreement in certain quarters. The contention of some tax consultants and even certain assessing officers was that since the gains on proceeds of endowment plans  (the ones not eligible for exemption under Section 10(10D))  were treated as ‘income from other sources’, thus attracting tax at marginal rate, the same rule should apply to ULIPs, too. Now, however, there is clarity post the budget announcements,” says Mayank Mohanka, founder-director, TaxAaram.com and a chartered accountant.

Therefore, going forward, there will be no ambiguity over how gains from such non-exempt ULIPs would be taxed. According to insurance officials Moneycontrol spoke to, this is a positive development from the perspective of life insurers as well as high net-worth policyholders, as it is clear that the ULIP gains will be taxed at a concessional rate of 12.5 percent (long-term capital gains tax rate on equities) and not the slab rate, as would have been the case were the profits treated as income from other sources.

Will a Ulipholder pay tax at the LTCG rate of 12 percent even if she chooses to direct her premiums tinto her Ulip’s debt or balanced fund option?

“Going by the language used in the budget documents as well as the I-T department’s FAQs, such ULIPs will now be treated at par with equity-oriented funds, but subject to certain conditions,” says chartered accountant Nitesh Buddhadev, founder, Nimit Consultancy.

He points to the explanation in the Finance Bill that possibly eliminates the scope for a tax arbitrage over debt mutual funds. That is, at least 65 percent of your Ulip premiums will have to be invested in equity assets for your policy to be treated as an equity-oriented fund. “…the minimum requirement of ninety per cent or sixty-five per cent, as the case may be, is required to be satisfied throughout the term of such insurance policy,” the Finance Bill states.

Will this change the taxability of maturity proceeds of endowment policies too?

“The profits on the proceeds of endowment policies that are not exempt under Section 10(10D) will qualify as ‘Income from other sources’,” says Buddhadev. They will be added to the policyholder’s income and taxed as per the slab rate applicable to her.

Will the life insurance proceeds that nominees get upon the policyholders’ death also be taxed?

No, death claim proceeds do not attract any tax.