Will I be taxed if I surrender ULIP after 5 years

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Tax if I  surrender ULIP after 5 years
Introduction

ULIPs can be considered as those useful financial tools that can be used to bridge the gap between the various investment options along with the added advantage of significant tax savings. Life insurance products like ULIPs are more reliable wealth creation solution over the long term, keeping in mind the returns, protection and tax savings, all combined in one product.

ULIP permits investing one’s premium in a mix of debt and equity funds in varying proportions, allowing inter-fund transfers through switches and all this with no tax liability. A ULIP is an insurance plan where the premium paid is invested in equity, debt, or money market instruments.


Why invest in ULIPs?

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.

What is a lock-in period in ULIP?

A lock-in period is a stipulated time during which if the policyholder surrenders or discontinues the policy, the policyholder won’t receive the payout. Only after completion of the lock-in period, which is 5 years in ULIP, the policyholder will receive the payout.

Tax on ULIP surrender after 5 years

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 tax on ULIP surrender after 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. 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 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. The surrender value of ULIP is otherwise added to your income and taxed as per applicable slab rate if surrendered before five policy years.

One must try and avoid exiting a ULIP as soon as the lock-in period ends. The possible reasons are:

  • Charges in the initial years of ULIP are high. There are a few charges in ULIP . In case of a ULIP, the premium allocation charge is deducted before investment of premium, funds allocation charges, fund management fee, policy administration fee, are deducted through either cancellation of units or by adjusting the NAV. The deduction is higher in the first year and substantially reduces over time. By the end of lock-in period and beyond, these charges come down to a point where it doesn’t impact the funds. Also, exiting after lock-in period ends, you will not reap the real benefits. You will end up getting a comparatively lower returns in ULIP.
  • Stay in the game of ULIP to reap the benefits that ULIP offers. ULIP is a long-term investment game. You can exit from ULIP after 5 years; however, it is not advisable even after lock-in period ends. To reap the benefits, you should continue and stay invested for a long period say 15-20 years. If you think that the funds are not performing, you may want to go for switching your funds. The performance is purely related to market fluctuations, as it is in the case of equity, you may want to stick around for some time until the market bounces back, instead of just the withdrawal of ULIP. So, to reap the benefits, you should probably stay invested for 15-20 years.

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