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Is income tax to be paid on ULIP surrender?

Why you should not surrender ULIP
Introduction

Most investors invest in ULIPs as they are one of the most viable tax saving instrument. It is so because they are a hybrid of both insurance and investment instruments, which gives annual benefits as an investment instrument and tax benefits as insurance instruments, as Income Tax considers ULIPs as an insurance product. ULIP also provides various other benefits to an investor.

The majority of individuals check the annual tax benefit to save the tax liability before investing in any financial instrument, but it’s wise enough to check the tax implication on the maturity of insurance policy, ULIP or any other investment. ULIPs provide deduction under section 80C equal to the amount of premium paid for ULIP, but it’s significant to focus on the tax benefit on ULIP maturity.

If you want to know about the income tax on ULIP surrender you should know that as per law, upon the completion of the tenure of your ULIP, when they mature, the total amount received by you or your nominee will be completely exempted from tax under section 10(10D). But the tax benefits can only be availed if the conditions stated in Income Tax Act 1961 are fulfilled in respect of insurance premiums.


Tax implications

With the announcement of LTCG tax on equity investments, returns from unit-linked insurance plans seem more attractive. The investment component in a ULIP works like a mutual fund but with a different cost structure. It is guided by different income-tax rules. As per section 10 (10D) of the income-tax Act, if the sum assured in a life insurance policy is at least 10 times the annual premium, then proceeds from the policy—maturity or early surrender—are tax free, given ULIPs come with a lock-in of 5 years. However, the death benefit is tax free. This is a plus for ULIPs, in view of the proposed LTCG tax of 10.4% on equity investments through mutual funds.

This has revived a debate of ULIPs versus mutual funds, of convenience of both and the efficiency of keeping insurance and investments separate by buying term plans and investing in mutual funds. Though now experts favour ULIPs , are cautious about recommending these as investment products.

If you are confused about the income tax on ULIP surrender, here are a few reasons you should look up to before doing so.

Most investors invest in ULIPs as they are most viable tax saving instrument, It is so because they are a hybrid of both insurance and investment instruments, which gives annual benefits as an investment instrument and tax benefits as insurance instruments, as Income Tax considers ULIPs as an insurance product.

The majority of individuals check the annual tax benefit to save the tax liability before investing in any financial instrument, but it’s wise enough to check the tax implication on the maturity of insurance policy, ULIP or any other investment. ULIPs provide deduction under section 80C equal to the amount of premium paid for ULIP, but it’s significant to focus on the tax benefit on maturity.

As per law, upon the completion of the tenure of your ULIP, when they mature, the total amount received by you or your nominee will be completely exempted from tax under section 10(10D). But the tax benefits can only be availed if the conditions stated in Income Tax Act 1961 are fulfilled in respect of insurance premiums.

Surrendering before and after the lock-in period

What happens if the policy is surrendered before the lock-in-period of 5 years? 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. Let’s discuss with an example, if surrender value of ULIP is Rs. 3,00,000 and total income apart from surrender value is Rs. 15,00,000, the total income will be Rs. 18 lakhs and the entire income will be taxed as per slab rate.

Similarly, what about the implications of income tax on ULIP surrender? 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. Let’s take the previous example as mentioned above, if surrender value of ULIP is Rs. 3,00,000 and total income apart from surrender value is Rs. 15,00,000, the total income will be Rs. 15 lakhs and the entire income is taxed as per slab rate.

So most people have queries about implications of income tax on ULIP surrender. The answer is, if you have completed 5 years, there will be no surrender charge and the surrender value will also be tax free. The surrender value of ULIP is otherwise added to your income and taxed as per applicable slab rate if surrendered before five policy years

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