Budget 2025 has brought significant clarity to the taxation of unit-linked insurance policies (ULIPs), resolving years of ambiguity that left investors and tax professionals uncertain about how profits from these policies would be taxed.
Issuing a clarification on income on redemption of ULIPs, finance minister Nirmala Sitharaman on Saturday announced that ULIPs that do not qualify for the exemption under clause (10D) of section 10 will be treated as a capital asset.
In other words, short-term capital gains (STCG) from ULIPs will be taxed at 20%, and long-term capital gains (LTCG)—for investments held for over 12 months—will be taxed at 12.5%. Furthermore, profits exceeding ₹1.25 lakh will be exempt from tax.
For perspective, Section 10(10D) exemption under the Income Tax Act provides tax-free maturity proceeds on life insurance policies, including ULIPs, provided certain conditions, such as premium limits relative to the sum assured, are met.
Before this change, there was confusion over how profits from ULIPs would be classified. “It was unclear whether these gains would be taxed as capital gains or as ‘income from other sources’,” said Amit Singhania, partner at Areete Law Offices. “This led to uncertainty, as the tax rates could have been significantly different, with long-term capital gain tax at 12.5%, compared to a potential flat rate of 30% if treated as income from other sources.”
To be sure, the Finance Act, 2021, had already placed restrictions on tax exemptions for ULIPs, but the latest amendment provides further clarity around the tax structure for these investments.
Aarti Raote, partner at Deloitte India, said that the earlier confusion has now been addressed, providing greater certainty for investors. “Earlier there was ambiguity on how ULIPs were taxed. With the new amendment, it is clear that ULIPs will have tax treatment similar to equity mutual funds. This amendment is more of a clarification than a provision,” she noted.
CA Prakash Hegde points out that this amendment resolves the confusion specifically regarding ULIPs issued before February 2021. He noted, “With this amendment, they have made it clear that taxable amounts from ULIPs will be treated as capital gain, avoiding the confusion on the head under which the same is taxable, particularly in respect of ULIPs issued before 01 February 2021.”
Vivek Sharma, investments head at Estee Advisors, critiques ULIPs as “structurally flawed instruments that combine insurance with investments” and believes they fail to effectively serve either purpose.
“They are aggressively marketed to enhance insurance penetration in our underinsured population. However, the insurance coverage they provide is minimal, and investors would achieve better returns by investing in mutual funds. Insurance and investments should remain separate,” he adds.
ULIPs have long been a complicated product, both in structure and taxation. The new changes bring clarity to taxation, but experts argue that they do not address the core issue of high costs, lack of transparency, and poor liquidity.
The mandatory five-year lock-in period remains a significant drawback, limiting investors’ ability to exit even if they realize they have mis-sold the product.
Moreover, while ULIPs with annual premiums exceeding ₹2.5 lakh will now be taxed like equity investments—with LTCG at 12.5% after one year and an exemption of ₹1.25 lakh per year—the taxation complexity remains.
Vivek Sharma explains, “Taxation of ULIPs is complex. They are taxed at different stages—premiums qualify for deductions under Section 80C, and maturity proceeds are tax-free under Section 10(10D) if premiums are within limits. However, if surrendered within five years, tax benefits are reversed. Death benefits remain tax-exempt.”
While the tax treatment now may look attractive, the true cost of ULIPs, their lower transparency, and the inability to freely exit should be carefully considered before investing.
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