Taxation on ULIP Surrender – Before or after 5 Yrs

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Purchased ULIP long back but now decided to surrender it? First, understand the taxation on ULIP Surrender. Many of us buy ULIPs either because forced by someone or with our own intention to invest. However, after few years, we feel that ULIPs are not worthy to invest in. Hence, we wish to surrender. There may be a certain loss if you surrender. However, understanding the taxation on ULIP surrender is also important for you.

Taxation on ULIP Surrender

To understand how the entire taxation part of ULIP (especially after the 2021 Budget), then refer my latest post “Budget 2021 – All about the Taxation of ULIPs”. However, in this post, my concentration is on the taxation of ULIP surrender.

Taxation on ULIP Surrender – Before or after 5 Yrs

Let us divide this issue into two parts. One is if you are surrendering before 5 years completion. Another is after 5 years.

Taxation on ULIP Surrender – Before 5 years

We all know that ULIPs will come with 5 years lock-in. But you are allowed to discontinue the policy before 5 years also. However, you will get the invested money after 5 years.

If you stopped the premium payment and requested for surrender before 5 years’ completion, then risk-cover will cease. But as I told you, the surrender value incurred is paid only at the end of the 5-year term. One more important aspect you have to consider is that you will not get the fund value as on the surrender date. The pay-out made post the lock-in period is subject to multiple deductions. When you apply for surrendering your policy, certain discontinuance charges are levied.

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After deducting the discontinuance charges the remaining fund value is transferred to the Discontinued Policy (DP) fund. Your funds will continue to remain in the DP fund until the end of the lock-in period. During this tenure, a fund management fee may be charged, not exceeding 0.5% of the fund value. This fund is also eligible to earn interest at about 4% per annum to provide a minimum guaranteed return.

Now let us understand the taxation rule on whatever the money you receive after the lock-in.

a) If you claimed the benefit under Sec.80 C

If you claimed the deduction under Sec.80 C during your policy period, ULIP surrender before 5 years is considered as premature closure. Hence, all tax deductions claimed against ULIP will be accounted as income and taxed according to your tax slab. The surrender value will also be subjected to Tax Deducted at Source (TDS).

Do remember that it is not the last year’s deduction only added to your income, but all the previous years where you claimed the deduction under 80C are added to your income. Assume that you purchased the ULIP in 2016 and for the FY 2016-17, 2017-18, and 2020-21, you claimed the deduction under 80C but not claimed the deduction for FY 2018-19 and 2019-20. Then, whatever the deduction you claimed for those 3 financial years is considered as an income while receiving the surrender value after 5 years. However, two financial years where you have not claimed 80 C benefits are not considered as income.

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b) If you have not claimed the benefit under Sec.80 C

Here is the confusion. There is no clarity on this aspect. Only one Insurer (Edelweiss Tokio Life Insurance) is mentioned as below.

“If the policy is surrendered before the lock-in period of 5 years, then the entire surrender value will be treated as income for the current year and will be added in Gross Total Income and thus will be taxed as per applicable tax slab rate of the individual.”

This means the entire amount (not profit) is taxable as per your tax slab in the year when you receive such premature ULIP amount after 5 years.

But no other insurers are clear on this and in fact, I found that Income Tax law is also silent on this. Hence, my assumption is that if you surrender ULIP before 5 years and if you availed any tax benefit under 80 C, then it will be reversed as I mentioned above. However, if you have not availed any tax benefit under Sec.80 C, then the surrender value is tax-free because you are receiving it after 5 years of lock-in.

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Taxation on ULIP Surrender – After 5 years

Here it is very clear. If you surrender your ULIP policy after the completion of 5 years, then the entire surrender value is tax-free. In fact, there are no exit charges applicable on ULIPs if you surrender them after 5 years of completion.

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Basu Nivesh

Basu Nivesh

Basav is a SEBI Registered Investment Adviser (SEBI RIA) practicing the Fee-Only Financial Planning Service. He is a CFP (Certified Financial Planner) and blogger at Basu Nivesh. He services around 300+ satisfied clients.
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