Life insurance is a long-term commitment. Still, not many people complete the tenure of their insurance policy, which also gets reflected in the low persistency ratio of the industry. For example, Life Insurance Corporation of India or LIC, which is the largest insurance player in terms of market share, has a 61st-month persistency ratio of just 44 per cent. This means out of its every 100 only 44 policies are continued beyond 5 years.
Though the reason could be anything from mis-selling to lack of funds but leaving the policy midway could be a costly mistake. Not only do you have to pay high surrender charges through the nose but may also pay huge tax on the surrender value. Here is a lowdown on how the surrender value is taxed in the case of unit-linked plans.
Tax rules in case of surrender of Unit Linked Insurance Plans (ULIPs)
ULIPs are investment policies that allow you to park money in different avenues ranging from equities, debt to money market instruments. It is a long-term plan where you are allowed to claim the premium paid as a deduction under Section 80C of the Income Tax Act. The proceeds received under a life insurance policy including ULIP are exempt for tax under section 10(10D) of the IT Act provided that the premium payable in respect of such policy does not exceed 10 per cent of the actual sum assured for any year during the policy term for policies issued after April 01, 2012.
But what happens if you surrender the plan before the lock-in period of 5 years?
Surrendered before the lock-in period of 5 years: "If the policy is surrendered before 5 years, then the entire surrender value will be treated as income for the current financial year and will be added to gross total income. It will be taxed as per the applicable tax slab rate of the individual," said Sujit Bangar, Founder, Taxbuddy.com. For example, if the surrender value of ULIP is Rs 5,00,000 and taxable income is Rs 10,00,000, the total income will be Rs 15 lakh and the entire income will be taxed as per slab rate.
Surrendered after the lock-in period of 5 years: If the policy is surrendered after the lock-in period of 5 years, then the surrender value will be exempt from taxation and assured can avail the tax benefit. “So, most people have queries about the implications of tax on ULIP surrender after 5 years. The answer is, if you have completed five years, there will be no surrender charge and the surrender value will also be tax-free,” said Bangar.
What if the policy is purchased after 1st Feb 2021 and the premium paid is above Rs 2.5 lakh? In Budget 2021, it was announced that if the premium paid for ULIP is more than Rs 2.5 lakh, then proceeds would be taxed like capital gain.
Shailesh Kumar, Partner, Nangia & Co LLP said, "Finance Act, 2021 amended the section to provide that exemption under section 10(10D) of the Act shall apply only if the premium payable in respect of ULIPs issued on or after February 01, 2021, does not exceed Rs 2.5 lakh in any year during the policy term. It has also been provided that where the premium is payable for more than one ULIP then the exemption shall be available only for ULIPs where the aggregate amount of premium does not exceed Rs 2.5 lakh for any year during the policy term. Hence, if the policy is bought after Feb 1 2021 and the premium amount is more than Rs 2.5 lakh, then the surrender value becomes taxable.
Tax Rates: Generally, a ULIP may be equity-based, debt-based, money market based, among other options. An equity-oriented ULIP shall be considered as a long-term capital asset when it is held for 12 months or more. On the other hand, ULIP, other than equity oriented, shall be considered as long term if held for 36 months or more.
"Long term gains from equity-based ULIP shall be taxed at the rate of 10 per cent without any indexation and short-term gains form the same shall be taxable at the rate of 15 per cent. For ULIPs other than equity-based, long-term gains shall be taxed at the rate of 20 per cent after giving the benefit of indexation and short-term gains shall be taxed at normal tax rates," said Kumar.
Importantly, any sum received on the death of a person remains exempted under section 10(10D) without the above restrictions.
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