ULIP Fund Switch Tax: Is It Tax-Free? Rules Explained 2026

Written by : Knowledge Centre Team

2026-08-06

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Flexibility to switch funds is one of the blessings when it comes to maximising your returns from any investment. When you invest in a ULIP or Unit Linked Insurance Plan, it offers a convenient wayto access both market-linked returns and life cover benefits with one tool. You can easily switch between funds based on your risk tolerance and market sentiments.

Now, a big concern that many people considering ULIP investment have is regarding the impact of ULIP fund switching on their taxes. Well, in addition to helping you rebalance your returns, fund switching may also attract certain tax implications. What must be understood here is that this happens only under special circumstances.

Understanding the taxability of ULIP and what a fund switch in ULIP is can help you make the most of your ULIP investment and switch funds with confidence.

Key Takeaways

ULIP allows tax-free fund switches, unlike mutual funds
If the annual premium exceeds ₹2.5L, LTCG tax applies at 10%
If surrendered before 5 years, the benefits are reversed, and the amount is taxed
ULIP calculator helps you plan investments and estimate returns
ULIPs offer free fund switches, making them adaptable to market changes

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Does Switching Funds Within a ULIP Attract Tax?

One of the biggest advantages of a ULIP is that switching funds within the policy does not attract tax. Unlike mutual funds, where each transaction can have tax consequences, ULIPs allow you to move your money across funds without worrying about immediate tax deductions. This tax-free switching feature is useful for the following reasons:

It allows you to rebalance your portfolio without incurring capital gains tax.
You can switch from high-risk funds to stable ones during market downturns without additional financial burden.

Scenario	Tax Implication
Switching between funds within the same ULIP	No tax applicable
Withdrawing a partial amount before 5 years	Taxable
Surrendering the policy before 5 years	Taxable
Maturity benefits (if the aggregate premium exceeds ₹2.5L in any policy year)	Taxable under Long-term Capital Gains (LTCG)
Maturity benefits (if the aggregate premium stays within ₹2.5L in any policy year)	Tax-Free under Schedule II(2) of the Income Tax Act, 2025 (earlier Section 10(10D) of the Income Tax Act, 1961)

Tax Implications on ULIP Withdrawals and Maturity

Understanding the tax implications of Unit Linked Insurance Plans (ULIPs) is crucial for maximising returns while ensuring compliance with tax laws. While ULIPs offer tax benefits under Section 123 of the Income Tax Act, 2025 (earlier Section 80C of the Income Tax Act, 1961) and Schedule II, Clause 2 (earlier Section 10(10D)), these advantages depend on factors such as policy tenure, premium amount, and withdrawal timing.

The taxability of ULIP proceeds evolved significantly following the changes introduced via the Union Budget 2021, and this framework has continued to apply since, with certain aspects further clarified in the Union Budget 2025. Here’s a breakdown of how these tax implications work and impact withdrawals and maturity benefits:

Short-Term vs Long-Term Capital Gains Tax

The tax treatment of ULIP gains depends largely on how long the policy is held, making it important to understand the distinction between short-term and long-term capital gains

Short-Term Capital Gains (STCG):

If you surrender or withdraw from a ULIP before completing one year, the gains are considered short-term capital gains. For equity shares, units of equity-oriented funds, and listed business trust units, the reduced tax rate of 20% will apply starting from 23rd July 2024.

Did You Know?

Pension-focused ULIP sales grew nearly 10-fold in FY26 compared to the previous year

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Long-Term Capital Gains (LTCG):

For ULIPs held for more than one year, the gains are treated as long-term capital gains. Building on the amendments to the Union Budget 2021, the Union Budget 2025 further clarified that ULIPs with annual premiums exceeding ₹2.5 lakh are now classified as capital assets.

Consequently, the maturity proceeds from such policies are subject to LTCG tax at 12.5% under Section 198 of the Income Tax Act, 2025 (earlier Section 112A of the Income Tax Act, 1961). Remember, this is only applicable if the fund is held for over a year, thereby aligning it with equity-oriented mutual funds. Moreover, an exemption of LTCG up to ₹1.25 lakh is available annually.

What Happens if You Withdraw Before Five Years?

ULIP investments come with a five-year lock-in period. If you withdraw before that:

Tax Implication: The amount withdrawn will be added to your taxable income and taxed as per your applicable income tax slab rate.
Reversal of Tax Benefits: Any tax deductions previously claimed under Section 123 (previously Section 80C) for the premiums paid will be reversed, increasing your taxable income for that financial year.

Impact of Premium Amount on Taxation:

Policies Issued Before February 1, 2021: Maturity benefits from these ULIPs remain tax-free under Schedule II, Clause 2 (previously Section 10 (10D), irrespective of the premium amount, provided other conditions are met.

Policies Issued On or After February 1, 2021: If the annual premium exceeds ₹2.5 lakh in any year during the policy tenure, the maturity benefits are taxable under the LTCG provisions. If the premium is within ₹2.5 lakh, the maturity benefits remain tax-exempt under Schedule II(2).

Clarification on Taxable ULIPs

The Union Budget 2025 has clarified that ULIPs with annual premiums exceeding ₹2.5 lakh are not eligible for exemption under Schedule II, Clause 2 (earlier Section 10(10D)), and are instead treated as capital assets.

Consequently, the proceeds from these ULIPs will be taxed under the head 'capital gains' rather than 'income from other sources'. This, in turn, has brought more transparency and consistency to their tax treatment.

How Are Capital Gains Calculated in a ULIP Plan?

For ULIPs that don't qualify for exemption under Schedule II, Clause 2 of the Income Tax Act, 2025 (earlier Section 10(10D)), capital gains are computed as follows:

Identify the amount received: This includes the maturity value, surrender value, or any bonus paid out under the policy.
Deduct the aggregate premium paid: Subtract the total premiums paid over the policy's tenure (till the date of receipt) from the amount received. The balance is your taxable capital gain.
Classification as an equity-oriented fund: Such ULIPs are deemed units of an equity-oriented fund for tax purposes, so no indexation benefit applies on the premiums paid.
Apply the applicable rate: Gains are taxed as STCG at 20% (held for less than 12 months) or LTCG at 12.5% (held for more than 12 months), with an annual LTCG exemption of up to ₹1.25 lakh.

This computation follows the mechanism prescribed under Section 67 of the Income Tax Act, 2025 (earlier Section 45(1B) read with Rule 8AD of the Income Tax Act, 1961).

Conclusion

ULIPs are indeed a fruitful investment option for those with a low to high market risk appetite. With insurance coverage and market-linked benefits, the tax exemption is just like a cherry on top. However, switching funds also impacts your overall investment return. With recent updates in tax regulations, ULIPs with higher annual premiums now fall under capital gains taxation, making it essential to plan your investments wisely.

At Canara HSBC Life Insurance, we are committed to helping you make informed financial decisions by making a ULIP calculator easily accessible on our official website. Whether you're looking to switch funds, withdraw, or plan for maturity, taking calculated steps is the key to maximising your investment benefits.

Glossary

ULIP: A hybrid plan combining insurance and investment with flexible fund switching
Fund Switching: The process of moving investments between different funds within a ULIP
STCG: Profits from the sale of assets held for one year or less, taxed at a higher rate
LTCG: Profits from the sale of assets held for more than one year, usually taxed at a lower rate
ULIP Calculator: A tool to estimate returns and tax implications of ULIP investments

FAQs

No, switching funds within a ULIP is tax-free, unlike mutual funds, a fund switch in ULIP is treated as a redemption and attracts capital gains tax.

If withdrawn before 5 years, any deductions previously claimed under Section 123 (earlier Section 80C) are reversed. The withdrawn amount is added to taxable income, and tax on ULIP withdrawal is taxed at your applicable slab rate.

A ULIP calculator helps estimate returns, plan fund allocation, and understand tax implications before investing.

ULIPs offer tax-free fund switching, while mutual funds attract capital gains tax on every redemption or switch.

Yes, ULIPs allow seamless switching between equity and debt funds based on market conditions and investment goals.

Disclaimer - This article is issued in the general public interest and meant for general information purposes only. The views expressed in this blog are solely those of the writer and do not necessarily reflect the official policy or position of Canara HSBC Life Insurance Company Limited or any affiliated entity. We make no representations or warranties of any kind, express or implied, about the completeness, accuracy, reliability, suitability, or availability with respect to the blog or the information, products, services, or related graphics contained in the blog for any purpose. Any reliance you place on such information is therefore strictly at your own risk. You should consult with a qualified professional regarding your specific circumstances before taking any action based on the content provided herein.

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Switching ULIP Funds: What Are the Tax Implications?

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Does Switching Funds Within a ULIP Attract Tax?

Tax Implications on ULIP Withdrawals and Maturity

Short-Term vs Long-Term Capital Gains Tax

Short-Term Capital Gains (STCG):

Did You Know?

Long-Term Capital Gains (LTCG):

What Happens if You Withdraw Before Five Years?

Impact of Premium Amount on Taxation:

Clarification on Taxable ULIPs

How Are Capital Gains Calculated in a ULIP Plan?

Conclusion

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