ULIP vs Mutual Fund Taxation Differences Explained

ByBusines Newswire

When choosing between a unit-linked insurance plan (ULIP) and a mutual fund, many investors focus on returns. But tax treatment also plays a major role in shaping actual gains. After Budget 2025, the taxation rules for ULIPs have become more aligned with mutual funds. However, a few key differences remain. This article explains those taxation differences clearly and also touches upon other relevant factors like costs, lock-ins and liquidity.

How Are ULIPs Taxed Today?

A ULIP combines life insurance and investment into one policy. Earlier, the maturity amount received from ULIPs was fully exempt under Section 10(10D). This benefit applied regardless of how much premium you paid, making it popular among high-income investors.

However, Budget 2025 introduced new rules for ULIPs. If the total premium across your ULIP policies crosses ₹2.5 lakhs in a financial year, the maturity amount will no longer be fully exempt. Here is what the revised rule says:

  • If you hold the ULIP for more than 12 months, gains will be taxed at 12.5%
  • If you surrender or switch within 12 months, gains will be taxed at 20%

This applies only to the investment portion of the policy. The insurance benefit remains exempt. The tax applies from April 1, 2026, but only to policies where the premium crosses the specified threshold.

If your premium stays within ₹2.5 lakhs per year, Section 10(10D) exemption still applies, subject to other conditions like minimum holding period and sum assured multiple.

How Are Mutual Funds Taxed?

Mutual funds are taxed based on the type of fund and how long you stay invested. There is no link to insurance or premium limits.

For equity mutual funds:

  • Holding beyond 12 months qualifies as long-term. Gains are taxed at 12.5%
  • Selling within 12 months attracts short-term tax at 20%

For debt mutual funds:

  • Holding period above 24 months qualifies as long-term. Gains are taxed at 12.5%
  • Selling before 24 months adds the gain to your income, taxed at your slab rate

There is also a ₹1 lakh exemption on long-term capital gains from equity mutual funds in a financial year.

Section 80C Deductions: What You Can Claim

ULIPs qualify for tax deductions under Section 80C. You can claim up to ₹1.5 lakhs of your ULIP premium. But this limit includes other 80C items like PF, life insurance and principal repayment of home loans.

ELSS mutual funds also qualify under Section 80C, with a mandatory 3-year lock-in.

Both products offer tax-saving options, but you must choose based on whether you also need life cover or retirement planning.

Cost Differences Affect Post-Tax Returns

ULIPs come with multiple charges:

  • Premium allocation charges
  • Fund management charges (capped at 1.35%)
  • Mortality charges for insurance
  • Policy administration charges
  • Surrender charges for early exit

These charges reduce the actual invested amount and affect compounding. Over time, this can lower your effective returns.

Mutual funds have a single visible cost: the expense ratio. It ranges from 0.5% to 2.5%, depending on the fund type. There may be an exit load if you redeem early, but there are no layered deductions.

If cost efficiency is your goal, mutual funds offer a simpler and more transparent structure.

Lock-In and Liquidity: How Accessible Is Your Money?

ULIPs come with a mandatory 5-year lock-in. You cannot fully withdraw before this period, even if your financial needs change. Partial withdrawals may be allowed under specific conditions. ELSS mutual funds have a 3-year lock-in, while other mutual funds have no compulsory lock-in unless you choose a fixed maturity or a close-ended fund. If you need flexibility, mutual funds provide easier access to your money and lower penalties for exit.

Transparency and Oversight

Mutual funds are regulated by SEBI. You can track NAV, portfolio details and fund manager performance daily. Costs are standardised and published. ULIPs are governed by IRDAI. Disclosures have improved, but the structure is more complex. Costs are split across many heads, making it harder to estimate effective charges. Fund switching rules also vary across insurers. This difference affects how confidently investors can review or modify their plans over time.

How Should You Decide?

If you want a product that offers market-linked growth with low charges and easy liquidity, mutual funds offer a more efficient option. You can choose between equity, debt or hybrid funds based on your risk and goals.

If you want investment and life insurance in one product and you plan to stay invested for a longer period, a unit linked insurance plan may suit you. Just keep the premium under ₹2.5 lakh a year if tax-free maturity is a priority.

For those looking to build a retirement corpus, a unit linked pension plan can enforce discipline. But withdrawals may still be taxable, depending on the structure.

Conclusion

Taxation is no longer the only deciding factor between ULIPs and mutual funds. After Budget 2025, both products face similar tax rates for long-term and short-term gains in many cases.

What matters now is the total cost, the lock-in, the level of flexibility you need and whether insurance is a priority. Understanding these differences can help you choose what works better for your life stage and financial plan.

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