All About Taxability Of ULIP On Surrender

Unit Linked Insurance Plans (ULIPs) are useful financial instruments that can be used to fill the gap between different investment options while also offering significant tax advantages.

To reduce their tax liability, most people check the annual tax benefit before investing in any financial product, but it’s also a good idea to consider the tax repercussions when an insurance policy, ULIP, or other investment reaches maturity. Under section 80C, the amount of the premium paid for ULIPs is deductible; nevertheless, it’s vital to keep in mind that ULIPs are taxed upon surrender.

In the situation where the ULIP is surrendered 

• Prior to the lock-in period – The full surrender value will be treated as your income for the current year, added to total gross income, and taxed at the individual’s applicable tax slab rate if the policy is surrendered before the 5-year lock-in term.
• Post-lock-in period – After the 5-year lock-in period, there are no surrender fees, and the insured is still eligible for the ULIP tax benefits if the policy is surrendered. 

The ULIP calculator is a simple tool that you can use to predict the return you might get at maturity by entering a few details.

The way ULIPs work

The Work Unit for ULIPs Linked Insurance Plans offers policyholders both investment advantages and a life insurance payout. The insurer offers coverage to the policyholder so that the nominee is eligible to collect the death benefits in the case of the latter’s untimely demise within the plan’s term. That takes care of the insurance part. 

• Under section 80C of the Income Tax Act of 1961, you may deduct the premiums you paid for ULIP plans from your gross income. However, the deduction is only worth up to Rs. 1.5 lakh. The amount of the Section 80C deduction is capped at 10% of the capital sum promised for policies issued on or after April 1, 2012, and 20% of the capital sum assured for policies issued prior to April 1, 2012, if the policy does not satisfy the Section 10(10D) requirements.

• The Income Tax Act of 1961’s Section 10(10D) covers the tax advantages of maturity. If certain requirements were met, as described in Section 10(10D) of the Income Tax Act of 1961, benefits on ULIP maturity were tax-free until Budget 2021. Now that we’re through the FY22 budget, it is possible to categorise the taxability of ULIP benefits based on maturity into two groups: taxability for ULIPs issued after or on February 1, 2021, and taxability for ULIPs issued before or on February 1, 2021. 

• ULIPs prior to February 1, 2021: In accordance with section 10(10D) of the Income Tax Act of 1961, ULIP returns at maturity are tax-free. This is only applicable to plans purchased after April 1, 2012, if the annual premium is less than 10% of the capital total insured (for the plans purchased before the said date, it is 20 percent). 

• ULIPs released on or after February 1, 2021: The earnings from ULIP plans issued on or after February 1, 2021, would henceforth be taxed as a capital gain at the time of payments under the policy if the aggregate premium exceeds Rs. 2.50 lakhs in any financial year during the policy’s tenure, it was declared in the budget for FY 2021–22. The only exception is any amount received by the nominee at the time of the policyholder’s passing away, in which case it is impossible to determine whether a ULIP is taxable upon surrender. It should be noted that top-up premiums will also be taken into account when calculating the annual premiums. The death benefits from the Keyman policy will be taxed (Employer-employee policy). Moreover, long-term capital gains calculated on the proceeds of ULIPs issued after or on February 1, 2021, that exceed Rupees One Lakh will be subject to a 10% tax.

You can use a ULIP calculator to estimate future returns and the value of a ULIP investment.

Tax on ULIP surrender after 5 years

What occurs if the insurance coverage is cancelled before the 5-year lock-in period? The full surrender value will be treated as your income for the current year, added to gross annual income, and taxed at the corresponding tax slab rate for the individual. Let’s use an example: If the taxability of ULIP plans at surrender is Rs. 3,00,000 and total income, excluding the surrender value, is Rs. 15,00,000, the total income equals Rs. 18 lakhs, and the entire amount is subject to tax at the applicable slab rate. 

The insured may gain from the ULIP tax benefits if the insurance is surrendered after the 5-year lock-in term because the surrender value is tax-free. The majority of consumers are, therefore, concerned about whether ULIPs are taxable upon surrender after five years. To address your question, there will be no fee for surrendering, and when five years have passed, the surrender value will no longer be subject to tax.