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Ref. No. KLI/22-23/E-BB/492
The question of whether ULIP surrender value is taxable or not is a complex one, as it depends on several factors. What are these factors? Let us find out.
Updated on: 16 May 2023
Investing in a life insurance policy is considered a long-term investment plan. This is because the longer you invest in an insurance policy, the better your returns. This goes with traditional and modern insurance plans like Unit Linked Insurance Plan. It is a financial tool that bridges the gap between various investment options and helps in significant tax savings.
Today, ULIP is considered a more reliable long-term wealth creation option than others, despite being a life insurance product. This is because if you look at some of the best ULIPs in India, you will note that an investor benefits from a good return on investment, protection, and tax-saving option in a single product.
However, despite being an excellent long-term investment option, many investors may have different reasons to surrender their ULIP policy. This article will discuss whether the ULIP policy surrender value is taxable. What are the charges and taxes to be paid if a policyholder discontinues the ULIP policy? But what are the taxability of ULIP on maturity and ULIP surrender value tax?
Surrender means to stop and submit. Here, ULIP policy surrender means you want to stop investing further and submit the policy to the insurer as a policyholder. This is done to receive the NAV of the ULIP policy as liquidity or ready cash.
As a policyholder, you can surrender a ULIP policy as and when you wish to. However, you must know that every insurance policy has a mandatory lock-in period. In the case of the ULIP policy, the lock-in period is five years. If you discontinue the ULIP policy before the lock-in period, you might have to pay the penalty, and the ULIP policy surrender amount is taxable. Thus, it is recommended not to discontinue the ULIP policy before the completion of five years.
The best time to surrender a ULIP policy is post its maturity time. Since you would have planned the long-term insurance and its maturity period, it is suggested that you extract the investment once it has reached maturity. This will help you in maximizing the returns. The best ULIP plans in India offer varied maturity periods of more than five years.
There can be two scenarios for surrendering the ULIP policy. One where the policy has not completed the lock-in period and the other where the policy has completed the lock-in period. Let us discuss them individually.
Prior to the Budget 2021 proposal, any gains made on ULIPs were entirely tax-free; however, going forward, the maturity amount will only be tax-free, provided the total yearly premium is up to ₹2.5 lakh. Any income earned from the annual premium that exceeds ₹2.5 lakh is subject to capital gains tax.
According to the experts, the ULIP policy surrender amount is taxable; if it is surrendered before the minimum lock-in period of five years, the total surrender value is considered income for the current fiscal year. Therefore, it is added to the total gross income for that fiscal year. Based on this value (total gross income after adding the deposited surrender value), the applicable tax slab is identified, and the individual has to pay taxes accordingly.
Note
If an individual discontinues the ULIP policy, they must pay additional discontinuation charges.
The tax on the ULIP surrender value governing your ULIP’s maturity advantages is referred to as ULIP taxation. As of right now, Section 80C deductions allow you to deduct the premiums you’ve paid for a ULIP. In accordance with the requirements of Section 10(10D) of the Income Tax Act of 1961, the payout you receive at the conclusion of the policy term is likewise tax-exempt. However, the following restrictions apply to these laws.
If you surrender your ULIP policy after the lock-in period is completed or after its maturity, you will not be charged any additional fee. Also, the taxability of ULIP on maturity is null, meaning it is exempt from taxes. Therefore, the entire surrender amount you receive after the ULIP policy maturity/lock-in period is tax-free.
If you are facing a financial emergency and need funds urgently, you can surrender your ULIP policy. However, keep in mind that the surrender charges can be high, and you may not get the entire amount invested.
If you are not satisfied with the returns generated by your ULIP policy, you can surrender it. However, keep in mind that market-linked investments can be volatile, and returns can fluctuate over time.
If your financial goals have changed, and your ULIP policy no longer aligns with them, you can surrender the policy. For example, if you had bought the policy for your child’s education, but your child has already completed their education, you can surrender the policy.
If you find a better investment opportunity that offers higher returns than your ULIP policy, you can surrender the policy. However, before you surrender your policy, make sure to compare the returns offered by the new investment opportunity with the ULIP policy.
If you find it difficult to pay the premiums for your ULIP policy due to financial constraints, you can surrender the policy. However, keep in mind that surrendering the policy can have an adverse impact on your financial goals.
The ULIP taxation on the surrender value depends on the period for which the policy was held before surrender. If you surrender your ULIP policy before the completion of five years, the surrender value received will be added to your income and taxed at your applicable income tax slab rate.
Suppose that Mr Sharma has been investing in a ULIP policy for the past five years, with an annual premium of ₹50,000. He recently decided to surrender the policy and received a surrender value of ₹2 lakhs. However, the total amount of premium paid over the years was ₹2.5 lakh. In this case, the surrender value of the ULIP policy is not taxable. The reason for this is that the surrender value is less than the total premium paid. Hence, the difference between the surrender value and the premium paid is treated as a loss, which can be claimed as a tax deduction.
Let’s assume that Ms Singh invested in a ULIP policy six years ago and has paid an annual premium of ₹75,000. She decided to surrender the policy and received a surrender value of ₹8 lakhs. However, the total amount of premium paid over the years was ₹4.5 lakh. In this case, the surrender value of the ULIP policy is taxable. The difference between the surrender value and the total premium paid (₹3.5 lakhs) is considered capital gains and taxed accordingly. The tax rate depends on the holding period of the ULIP policy. If the holding period is less than five years, the gains are taxed as per the individual’s tax slab rate. If the holding period is more than three years, the gains are taxed at 20% with indexation.
Assume that Mr Verma invested in a ULIP policy ten years ago and has paid an annual premium of ₹1 lakh. The policy had a maturity period of 15 years, and Mr Verma decided to surrender the policy after the maturity date. In this case, the surrender value of the ULIP policy is not taxable. The reason for this is that the policy has already completed the maturity period, and any amount received after the maturity date is not subject to tax.
The surrender value of ULIP policies is subject to ULIP taxation in certain circumstances. If the policy is surrendered before the completion of five years, the surrender value will be subject to ULIP taxation as per the income tax slab rate of the policyholder. However, if the policy is surrendered after the completion of five years, the surrender value will be tax-free.
It is important to note that the surrender value is calculated after deducting various charges such as premium allocation charges, fund management charges, mortality charges, etc. Therefore, it is advisable to carefully evaluate the surrender value and the tax implications before deciding to surrender the ULIP policy. It is also recommended to consult a financial advisor or a tax expert for a better understanding of the taxation of ULIP policy surrender value.
The best way to calculate the surrender value of the ULIP policy and applicable taxes is to ask your insurer. Then, seek a professional’s help and avail the best options!
1
ULIP (Unit Linked Insurance Plan) is a type of investment product that provides both life insurance and investment benefits. If the policyholder decides to terminate the ULIP policy before its maturity date, they may receive a surrender value which is the accumulated fund value of the policy minus surrender charges.
2
Yes, the ULIP policy surrender value is taxable as per the Income Tax Act 1961. If the policyholder surrenders the ULIP policy before completing five years, the surrender value is added to the policyholder’s income and taxed as per their income tax slab rate.
3
If the policyholder surrenders the ULIP policy after completing five years, the surrender value is tax-free. However, if the policyholder has availed of any tax benefits on the premiums paid during the policy term, they may have to pay tax on the gains in the year of surrender.
4
No, tax benefits are available only on the premiums paid during the policy term and not on the surrender value. The surrender value is taxed as per the Income Tax Act of 1961.
5
The surrender value of the ULIP policy is calculated by deducting the surrender charges from the accumulated fund value. The surrender charges vary from insurer to insurer and usually decrease with the policy’s tenure. The accumulated fund value is the total value of the investments made by the policyholder, including capital gains and losses, as per the prevailing market conditions.
In this policy, the investment risk in the investment portfolio is borne by the policyholder.
Kotak e-Invest
Features
Ref. No. KLI/22-23/E-BB/521