Ask whether a ULIP beats buying a term plan and investing the rest in a mutual fund, and the honest answer depends on one number: how much premium you pay across all your ULIPs each year.
Below ₹2.5 lakh, the ULIP keeps its tax-free maturity. That exemption beats an active equity fund and comes close to an index fund. Above ₹2.5 lakh, the exemption is gone. The ULIP then trails both alternatives, and the person most often sold a large ULIP is exactly that buyer.
The rule that decides it
Tax-free maturity is the single structural advantage a ULIP holds over an equity mutual fund. To keep it, a policy has to meet two conditions, and both are tested in every policy year.
- The ₹2.5 lakh premium limit. For ULIPs issued on or after 1 February 2021, the total annual premium across all the policyholder’s ULIPs must stay at or below ₹2.5 lakh in every year of the term.
- The 10% of cover limit. For ULIPs issued on or after 1 April 2012, the annual premium must not exceed 10% of the sum assured.
The exemption sits under Section 11 read with Schedule II, Ser. No. 2 of the Income Tax Act, 2025. That Act replaced the long-standing Section 10(10D) of the 1961 Act. If either condition is breached, maturity gains are taxed like an equity mutual fund’s: 12.5% on gains above ₹1.25 lakh.
Three details are easy to miss:
- The limit is aggregated. Two ULIPs with a combined annual premium of ₹3 lakh breach it, even though neither policy crosses ₹2.5 lakh on its own.
- The death benefit is unaffected. A sum received on the death of the life assured stays exempt, whatever the premium or the policy’s vintage.
- The ₹2.5 lakh limit is specific to ULIPs. Traditional non-linked policies issued on or after 1 April 2023 have a separate aggregate limit of ₹5 lakh.
A buyer paying ₹2 lakh a year therefore needs a sum assured of at least ₹20 lakh to stay exempt.
How the comparison is built
The same setup runs on both sides of the line:
- A 35-year-old buyer in good health with a 20-year policy and premium-paying term.
- A sum assured of ten times the annual premium.
- An identical 11.5% gross market return on every equity option.
The three routes are:
- 4G ULIP: FMC of 1.35%, with no allocation or administration charge. Mortality charges are refunded at maturity, and 1% of the premium is added to the fund in each of the first five years.
- Term plan plus index fund: matching cover at about ₹15,000 a year per ₹1 crore (online rates for a 35-year-old non-smoker), with the rest invested in an index fund at 0.2%.
- Term plan plus active fund: the same cover, with the rest in an active equity fund at 1%, the high end of the direct-plan range.
For both fund routes, tax is applied as a single redemption at maturity, with the ₹1.25 lakh exemption used once. A buyer who books gains within the exemption every year would pay less tax. That would widen the lead of both fund routes, so these figures are generous to the ULIP.
Below the threshold: ₹2 lakh a year, ₹20 lakh cover
| Route | Post-tax corpus after 20 years | Comparison |
|---|---|---|
| 4G ULIP, exemption intact | ₹1.29 crore | Baseline |
| Term plan + index fund at 0.2% | ₹1.33 crore | Index ahead by 3.1% |
| Term plan + active fund at 1% | ₹1.21 crore | ULIP ahead by 6.2% |
Before tax, the ULIP’s fund charge costs about 13% of the corpus an index fund would build. Once the index fund pays 12.5% on its gains at maturity and the ULIP pays nothing, most of that gap disappears. The index route still finishes ahead, but by 3.1%.
Against an active fund the ULIP wins outright, because the active fund carries a higher charge as well as the maturity tax the ULIP escapes. That lead holds between 5.2% and 7.3% across gross returns of 9% to 13%. If you would have bought an active fund anyway, a tax-free ULIP below the threshold is the better outcome.
Above the threshold: ₹5 lakh a year, ₹50 lakh cover
| Route | Post-tax corpus after 20 years | Comparison |
|---|---|---|
| 4G ULIP, exemption lost | ₹2.94 crore | Baseline |
| Term plan + index fund at 0.2% | ₹3.31 crore | Index ahead by 12.7% |
| Term plan + active fund at 1% | ₹3.01 crore | Active fund ahead by 2.5% |
With the exemption gone, nothing offsets the higher charge. The ULIP finishes behind both the index fund and a reasonably priced active fund.
Against the index fund, the shortfall is about ₹37 lakh on ₹1 crore of total premium. That lead holds between 12.1% and 13.0% across gross returns of 9% to 13%. The buyer with the largest balance is the one for whom a 4G ULIP is most clearly the wrong choice in equity.
What the corpus numbers do not show
The tables measure money at maturity. They do not measure what the policy stops you from doing along the way.
The five-year lock-in. A buyer who stops paying is moved to a discontinuance fund that earns the IRDAI-mandated minimum of 4% a year, whatever equity markets do in those years. You cannot exit at any price for five years.
The in-house fund universe. Free switching only works within the insurer’s own funds. If a better manager sits at a different fund house, you cannot move to them without surrendering the policy. Insurer fund menus also increasingly carry single-sector, single-factor and momentum options that did not exist five years ago.
The overlap between cover and corpus. A ULIP pays the highest of three amounts on death: the sum assured, the fund value, or 105% of premiums paid. Early in the policy this does not matter. Suppose a buyer dies in year three with a ₹20 lakh sum assured and a ₹10 lakh fund value. The family receives ₹20 lakh.
The constraint bites later. Once the fund grows past the sum assured, the cover adds nothing beyond money the buyer already holds, yet mortality charges keep being deducted until they are refunded at maturity. A term plan held alongside a mutual fund works differently: the family receives the sum assured in addition to the fund value, not instead of it.
Two arguments for the ULIP, tested
“Switching inside the policy is tax-free.” This is true. A mutual fund investor who rebalances between equity and debt pays 12.5% on gains above ₹1.25 lakh, while a ULIP holder does not. But it only matters if you actually rebalance. Most retail buyers hold a single equity fund for the full term, on either side.
“The lock-in forces discipline.” AMFI’s monthly SIP stoppage data shows that many retail SIP investors do not hold for the term they signed up for. A ULIP holder cannot exit, so they hold. But a buyer who would not stay invested without a lock-in is a different buyer. The unbundled route is not built for them.
The verdict
| Your annual ULIP premium (all policies) | What the numbers say |
|---|---|
| At or below ₹2.5 lakh | ULIP beats an active fund and trails a low-cost index fund by about 3% |
| Above ₹2.5 lakh | ULIP trails both the index fund and an active fund |
Below the line, a ULIP is a defensible choice for someone who would not have held an index fund anyway. Above it, the corpus trails every alternative on the shelf. That is where large-ticket ULIPs are most often sold.
Source: “The New ULIP and the Old Problem”, 1 Finance Magazine, June 2026 (Issue 11). Charge inputs from IRDAI Insurance Products Regulations, 2024. Tax treatment per Section 11 read with Schedule II of the Income Tax Act, 2025. Term insurance and fund expense rates per published rates of insurers and AMCs at the time of the analysis.
