ULIP Policy Maturity Tax Rules

What is the Tax Treatment of ULIP Maturity Proceeds?

The tax outcome at maturity is not the same for every ULIP plan. It depends on when the policy was issued, what premium you pay, and whether the policy qualifies under Section 10(10D). Here is how it works:

• For policies issued on or after April 1, 2012, the annual premium must not exceed 10% of the sum assured to qualify for tax exemption at maturity
• For policies issued before April 1, 2012, the threshold is relaxed to 20% of the sum assured
• If the ULIP is surrendered before completing five policy years, the proceeds become fully taxable in the year of receipt
• Death benefit received by the nominee is always tax-free under Section 10(10D), regardless of the premium amount or policy date
• If the policyholder passes away during the term, the nominee receives the higher of sum assured or fund value, and the entire amount is exempt from tax

Tax Exemption Under Section 10(10D)

The Section 10(10D) of the Income Tax Act is the provision that shields ULIP maturity proceeds from tax. However, it comes with specific conditions that must be satisfied throughout the policy term.

• The ULIP must complete the five-year lock-in without being surrendered
• Annual premium should stay within 10% of the sum assured for policies issued after April 2012
• For policyholders who are disabled or diagnosed with a critical illness listed under Rule 11DD, the premium cap is relaxed to 15% of the sum assured
• Both the principal and the gains at maturity become tax-free if all conditions under 10(10D) are met
• There is no TDS deducted on qualifying maturity payouts

Real-life example: Rohan buys a ULIP in 2020 with a sum assured of Rs. 15 lakh and pays an annual premium of Rs. 1.2 lakh. Since Rs. 1.2 lakh is well below 10% of Rs. 15 lakh (Rs. 1.5 lakh), Rohan’s maturity proceeds in 2030 are fully exempt under Section 10(10D). He also claims a deduction on the premium under Section 80C every year.

Tax Rules for ULIP Policies With Premium Greater Than Rs. 2.5 Lakh

The Finance Act 2021 brought in a rule change that significantly affects buyers of ULIPs issued on or after February 1, 2021. If the total annual premium across all your ULIP policies crosses Rs. 2.5 lakh in any year, Section 10(10D) exemption no longer applies to those policies.

Here is what changes in that scenario:

• Gains from such ULIPs get treated as capital gains, on the same lines as equity mutual funds
• If the policy is held for more than 12 months, the gains qualify as Long-Term Capital Gains (LTCG) and are taxed at 10% on gains above Rs. 1 lakh, without indexation benefit
• If held for less than 12 months, Short-Term Capital Gains (STCG) tax of 15% applies
• The Rs. 2.5 lakh limit is calculated on the aggregate of all ULIP premiums you pay in a financial year, not per individual policy
• Death benefit continues to remain tax-free even for high-premium ULIPs; the cap does not affect the nominee’s payout

Real-life example: Meena holds three ULIP policies purchased in June 2022, paying premiums of Rs. 1 lakh, Rs. 85,000, and Rs. 75,000 respectively. Her total annual ULIP premium adds up to Rs. 2.6 lakh, which crosses the threshold. At maturity, she cannot claim exemption under 10(10D). The gains from all three policies will be taxed as capital gains depending on the holding period.

Taxation on Partial Withdrawals

Partial withdrawals from a ULIP are only permitted after the mandatory five-year lock-in period ends. Once the lock-in is complete, you can withdraw a portion of the fund value without surrendering the entire policy.

For policies where the annual premium is below Rs. 2.5 lakh and the policy satisfies the conditions under Section 10(10D), partial withdrawals are tax-free. The insurer does not deduct TDS on such payouts, and the amount does not need to be declared as income in your tax return.

If your policy falls under the high-premium category where the aggregate premium crosses Rs. 2.5 lakh, partial withdrawals are treated differently. The gains component of each withdrawal becomes subject to capital gains tax. LTCG or STCG rates apply depending on how long the funds have been invested.

One thing many policyholders miss: insurers often cap the withdrawal limit at a percentage of the fund value. Several plans allow withdrawals of up to 20% of the fund value per year. Always check the policy document before making a withdrawal to avoid triggering unnecessary charges or affecting the policy structure.

Conclusion

ULIP taxation hinges on a few critical factors: the policy issue date, the annual premium, and how long you stay invested. The Rs. 2.5 lakh premium threshold introduced in 2021 is the dividing line for newer policies. Stay below it, and ULIPs offer a clean triple advantage: Section 80C deduction on premiums, tax-free growth, and a tax-free maturity corpus. Cross it, and the gains shift to capital gains taxation. Knowing which side of that line you are on can have a real impact on your post-tax returns over a 10 to 15-year investment period.