Budget 2026: How FM Sitharaman reshaped ULIP taxation in 2025 and what high-premium investors must know

In the Union Budget 2025, Finance Minister Nirmala Sitharaman moved to settle long-standing confusion around the taxation of high-premium Unit Linked Insurance Plans (ULIPs), a step that has important implications for investors from April 1, 2026. The amendment clarified that ULIPs with annual premiums exceeding Rs 2.5 lakh will now be taxed as capital gains, bringing them closer in treatment to market-linked investment products such as mutual funds.

Taxes on ULIPs

Under the new framework, gains from such ULIPs will be taxed based on the holding period. If the policy is held for more than one year, profits will attract long-term capital gains tax at 12.5 per cent. If surrendered or matured within a year, the gains will be taxed at the investor’s applicable income-tax slab rate. This replaces the earlier ambiguity over whether proceeds should be treated as “income from other sources” or as capital gains, an issue that had created compliance challenges for both taxpayers and insurers.

To understand the change, it is useful to revisit the earlier rules. Section 10(10D) of the Income Tax Act exempts maturity proceeds of life insurance policies from tax, provided certain conditions are met. For policies issued after April 1, 2012, the annual premium must not exceed 10 per cent of the sum assured for the maturity amount to remain tax-free. Additionally, under reforms announced in Budget 2021, ULIPs with annual premiums above Rs 2.5 lakh were excluded from this exemption, but clarity on how exactly they would be taxed remained incomplete.

No exemptions

Budget 2025 closed that gap by stating that ULIPs, which do not qualify for exemption under Section 10(10D) will be treated as capital assets and taxed under capital gains provisions. This aligns with Section 45(IB), which governs the taxation of ULIPs exceeding the Rs 2.5 lakh premium threshold, ensuring uniform treatment across all such policies.

The rationale behind the change lies in the evolving nature of ULIPs themselves. While designed as hybrid products combining insurance and investment, many high-premium ULIPs in recent years have leaned heavily toward the investment side. Insurers have introduced equity-oriented options, including mid-cap and small-cap funds, often marketing them in ways that resemble mutual fund offerings. This blurred the distinction between insurance and pure investment products, creating the need for clearer and fairer taxation.

ULIPs and tax relief

For investors, the new rules bring both clarity and a reality check. High-premium ULIPs can no longer be viewed primarily as tax shelters. Instead, they must be evaluated on the strength of their underlying investment performance and insurance coverage, much like any other market-linked product.

That said, ULIPs still retain features that differentiate them from mutual funds. Policyholders can switch between equity and debt funds within the plan without triggering capital gains tax during the policy term, a flexibility not available in mutual funds. ULIPs also allow tax-free partial withdrawals after the mandatory five-year lock-in, offering some liquidity later in the policy life.

However, mutual funds continue to score on transparency, wider fund choice and immediate liquidity, making them more suitable for investors focused purely on wealth creation rather than insurance-linked investing.