Confusing Premium with Proceeds: Many investors think exceeding ₹2.5 lakh in proceeds triggers tax. Actually, it's the annual premium that determines tax status. You can have a ₹3 lakh annual premium and receive ₹50 lakh proceeds — if LTCG applies, you pay 12.5% tax on the gain (₹50L minus total premiums paid), not on the entire ₹50 lakh.

Ignoring the Annual Limit: The ₹2.5 lakh limit is annual. If you paid ₹3 lakh in Year 1 and ₹2 lakh in Year 2, your exemption is lost entirely if the policy was issued after Feb 1, 2021. Even one year above the limit triggers taxability.

Forgetting to Aggregate Multiple ULIPs: If you have two ULIPs (issued after Feb 1, 2021) with ₹1.5 lakh and ₹1.2 lakh annual premiums, totaling ₹2.7 lakh, you exceed the threshold. The limit applies to aggregate premiums across all ULIPs, not individual policies.

Misunderstanding the Holding Period: The holding period is measured from issue date to encashment date, not from purchase of units. A policy issued on March 15, 2023, and encashed on March 10, 2025, is held for 23 months (just under 24) — if it's 23 months, it's STCG at 20% plus Cess, not LTCG.

Not Accounting for Cess: Many calculations show tax as 12.5% or 20% but forget the 4% Health & Education Cess, which makes effective rates 13% (LTCG) and 20.8% (STCG). This 0.8% difference adds up significantly on large gains.