Unit-linked insurance plans (ULIPs) are popular, as they are the only type of insurance policies that combine life cover and investment. Part of the premium gets deducted under various ULIP charges. The balance is invested in different asset classes, such as debt, equity, or a mixture of both types of funds.
Additionally, ULIPs are tax-savings products, and an amount of up to INR 1.5 lakh paid as a premium is tax-deductible under Section 80C of the Income Tax Act, 1961. Moreover, the maturity proceeds are tax-free under Section 10(10D) of the Act. Any policy benefits paid to your nominees in your absence during the duration are also tax-exempt under this section.
Tax implications on surrendering the ULIP
When you consider a ULIP investment, it is helpful to know the tax implication if you need to surrender the policy for some reason. The Government of India announced long-term capital gains (LTCG) tax on equity-linked mutual fund schemes, which has increased the attractiveness of ULIPs.
The investment in ULIP is similar to a mutual fund, but it has a different cost structure. According to Section 10(10D) of the Income Tax Act, 1961, the amount received on surrendering the ULIP is tax-free. However, this ULIP tax benefit is available only if the sum assured (SA) is at least 10 times the annual premium.
Surrendering the ULIP before the lock-in period
The ULIP tax benefits are available only if you stay invested for at least five years, which is the minimum lock-in period for these types of insurance policies. Therefore, if you surrender the policy before the lock-in period, the entire surrender value is added to your income and you will have to pay the income tax as per your tax slab. For example, assume your annual income is INR 10 lakh. You surrender your ULIP investment during the financial year and the amount received is INR 2 lakh. So, your total income is INR 12 lakh, and the tax payable is computed based on the current rates and your tax slab.
Surrendering the ULIP after the lock-in period
When you hold your investment for at least five years before surrendering the plan, you enjoy the EEE (exempt-exempt-exempt) benefit. This means the principal, interest, and the surrender value are all exempt from income tax. In the above example, your income will be capped at INR 12 lakh to determine your tax liability during the financial year. Because you surrendered the policy after the lock-in period, the surrender value of INR 2 lakh is not included in your income and is tax-free.
Moreover, when you surrender your policy after five years, the insurance company does not levy any surrender charges.
Tax implications for surrendering single premium ULIPs
As per the rules, the surrender value for ULIPs purchased after April 1, 2012, is tax-free if the single premium does not exceed 10% of the SA. However, if the premium exceeds 10% of the SA, the entire surrender value is added to your income and taxed as per your current tax slab.
Here is an example to help you understand. Assume that you purchased a ULIP on April 1, 2013, and paid a single premium of INR 5 lakh with a SA of INR 7.5 lakh. You surrender the policy on March 31, 2019, and receive INR 8 lakh. Because the premium exceeds 10% of the SA, the entire surrender value is taxable. You will have to show the net surrender value (calculated as total surrender value minus the total premium paid) in your income tax return (ITR). This amount is included under ‘income from other sources’ and taxed at your prevailing slab.
Nonetheless, these types of insurance policies have several plus points, which is why you should invest in ULIPs now.