Here are the tax implications for ULIPs on surrender

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tax implications for ULIPs on surrender
Introduction

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.

If you want to know about the taxability of ULIP on 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 taxability of ULIP on surrender, here are a few reasons you should look up to before doing so.

  • Charges in the initial years of ULIP are high: In a ULIP, various charges like 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 later, these charges come down to a point where it doesn’t impact the funds. This implies the money invested during the lock-in period is lower as compared to the later years of the ULIP investment when these charges are almost negligible.

    Consequently, exiting after lock-in period ends, you will not reap the real benefits. You will end up getting a comparatively lower returns in ULIP. If you surrender ULIP before 5 years, you may have to pay surrender charges plus money will be paid to you only after completion of the lock-in period. So, discontinuing or surrendering before lock-in period ends should be out of the question.

  • Stay in the game of ULIP to reap the benefits that ULIP offers: As mentioned before also, ULIP is a long-term investment game. To know about taxability of ULIP on surrender, you must know that you can exit from ULIP after 5 years but it is not advisable even after lock-in period ends. To reap the benefits, you should continue and stay invested for a long period of say 10-20 years. If you think that the funds are not performing, you may go for switching your funds. The scheme performance is purely related to market fluctuations. In any case, you may want to stick around for some time until the market bounces back, instead of just the withdrawal of ULIP. Moreover, if the market is underperforming at present, you can always check statistics to see how the scheme performed when the market did well, in the bull phase. And so, you should probably stay invested for 15-20 years to get the real results.

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