ULIP tax exemption: Can a top-up premium beyond 20% of sum assured make my policy taxable?

Many investors with old ULIP policies often wonder whether adding top-up premiums will affect their tax benefits. While the original policy may have qualified for exemption, additional contributions made later can change the tax treatment if the total premium crosses the prescribed limit. Today's Q&A explains such details in response to a query by a reader.

**Question: I hold a ULIP policy issued on 8 November 2005. The annual premium payable is ₹18,000, which is less than 20% of the sum assured of ₹1,00,000. The policy satisfies the conditions applicable under Section 10(10D) prevailing at the time of issuance. The policy permits top-up premiums, which are invested under the same policy number and reflected in the same fund account. **

For the life insurance policies issued between 1st April, 2003 and 31st March 2012, the exemption is available if the premium paid for any of the premium paid years did not exceed 20% of the sum assured. While computing this limit of 20%, any top-up premium paid is also taken into account.

So in case the premium paid during the year, including the top-up premium, exceeds 20% of the sum assured, the money received in respect of such life insurance policy will not be exempt.

There is no provision under the law to apply the exemption partly in respect of the regular premium of the policy and for the top-up premium paid on that policy. Once the premium paid during the year exceeds the threshold of 20%, the entire money received in respect of such policy loses its exemption and becomes taxable.

Since your annual premium is ₹18,000, you can pay a maximum of ₹2,000 every year as top-up premium in order to continue to enjoy the exemption. In case the top-up premium for any of the premium paying term exceeds ₹2,000 even by a single rupee, the policy loses its exemption.

Similar provisions are contained in section 11 read with item no. 2 of Schedule II of the Income Tax Act, 2025, which will apply in respect of money received for insurance policies on or after 1st April 2026.

The difference between the premiums paid and the money received is taxed as capital gains. The rates of taxation would vary depending on where the underlying fund of the ULIP policy is invested and the period during which the premiums are paid.

Profits attributable towards premiums paid within two years shall be treated as short-term capital gains and taxed at the slab rate. For those premiums paid beyond two years, the profits are taxed as long-term capital gains. The long-term capital gains shall be taxed at a flat rate of 12.50%. In case the fund invests more than 65% in listed equity shares, the long-term capital gains up to ₹1.25 lakh shall be tax-free as the same are taxed at zero rate.