Understanding Tax Implications When Switching ULIP Funds

2025-07-15

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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 approach to both market-linked and coverage benefits. 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 fund switching. Well, in addition to balancing your returns, it may also attract certain tax implications. What must be understood here is that it happens only under special circumstances.

At Canara HSBC Life Insurance, we understand the importance of financial security and peace of mind such insurance investments add to your life. So, let’s help you understand the tax implications of fund switching better.

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. It is crucial to keep on doing so 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 premium >₹2.5L per year)	Taxable under LTCG (Long-term Capital Gains)
Maturity benefits (if premium <₹2.5L per year)	Tax-Free

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 80C and Section 10(10D), these advantages depend on factors such as policy tenure, premium amount, and withdrawal timing.

The taxation of ULIP proceeds has evolved over the years, especially with changes introduced since the Union Budget 2021. Here’s a breakdown of how these tax implications work and impact withdrawals and maturity benefits:

1. Short-Term vs Long-Term Capital Gains Tax

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 business trust units that are listed, the reduced tax rate of 20% will apply starting from 23rd July 2024..

Did You Know?

In the financial year 2024-25, the sale of such assets up to 22nd July 2024 will be subject to a tax rate of only 15%.

Source: ClearTax

Long-Term Capital Gains (LTCG)

For ULIPs held for more than one year, the gains are treated as long-term capital gains. As per the Union Budget 2025, 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%. 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?

Unit linked insurance plan 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 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 Section 10 (10D), irrespective of the premium amount, provided other conditions are met.
Policies Issued On or After February 1, 2021: For these policies, if the annual premium exceeds ₹2.5 lakh in any year during the policy tenure, the maturity benefits are taxable under LTCG provisions. If the premium is within ₹2.5 lakh, the maturity benefits continue to be tax-exempt under Section 10(10D).

Clarification on Taxable ULIPs

The Union Budget 2025 has clarified that ULIPs are not eligible for exemption under Section 10(10D), specifically those with annual premiums exceeding ₹2.5 lakh. Such returns will be 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, will bring more transparency and consistency to their tax treatment.

Conclusion

ULIPs are indeed a fruitful investment combination for those with little 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.

Get in touch for more information today!

Glossary

ULIP (Unit Linked Insurance Plan): 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 (Short-Term Capital Gains): Profits from the sale of assets held for one year or less, taxed at a higher rate.
LTCG (Long-Term Capital Gains): 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, where capital gains tax applies.

If withdrawn before 5 years, tax benefits are reversed, and the withdrawn amount is added to taxable income.

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 transaction.

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.