It’s widely believed that insurance as an investment is a bad product and I’m in complete agreement with the same. But what if you’ve already invested your hard-earned money in ULIPs and you want to come out of it?
Be prepared for a big mess if your ULIP hasn’t completed 5 years and you’re thinking of surrendering the policy.
I am going to talk about the policies which have been purchased after 1st April 2012. And, where the sum assured is 10 times your premium. For example, if you are paying a premium of 50,000 per annum, the sum assured should be 5 lakhs.
(Okay, let me quickly make a clarification over here. Suppose you’ve purchased any ULIP after 1st April 2012 and the sum assured is less than 10 times your premium. In such cases, even the maturity amount is taxable. That is the reason, all pension plans are taxed even if they’re surrendered after 5 years.)
Now let us come back to the most essential point. What if the sum assured in the policy is 10 times or more than 10 times your premium? And you want to surrender the policy before 5 years (5 years is the lock-in period in all the ULIPs). How would the fund value and tax benefits which have been availed previously be treated in that case?
Let’s discuss the reversal of tax benefits (under Section 80C) which you had availed by showing the premium of ULIPs.
Also Read: Should I surrender my Jeevan Anand Policy
Tax Benefits Reversal
According to HDFC Life:
ULIP must be kept in force for 5 years to claim the deduction – The premiums must be paid regularly and the ULIP should also be continued in order to avail the tax benefits. In case you discontinue your ULIP before a time period of 5 years, you won’t be allowed any tax benefits. Any deduction allowed in the previous years shall get re-added to your income in the year during which ULIP is closed.
Here is the link for your reference:
It is not just the previous year; it is for previous years. Suppose you have paid 4 premiums for a ULIP and you surrender the ULIP in the 5th year. All the deductions which you’ve availed in the previous 4 years under Section 80C, will reverse and get added back to your income. The tax liability is indeed going to be very huge.
What if I have not availed any tax benefits from my ULIP policy, can I surrender? What would be the tax implication in that case. This mess is even bigger than the reversal of tax benefits.
Taxation On ULIP Surrender
Let me explain this with the help of an example of how the taxation on ULIP surrender works.
Suppose, you had purchased a ULIP having an annual premium of 1 Lakh. After 4 years, the fund performance is very bad. The fund value has now become 4.40 Lakhs offering you returns of around 6.40%. (I am assuming higher returns, nowadays, ULIPs are not even giving 4% returns after 4 years:-😊). You went to the insurance company and gave the request for surrender. The insurance company accepted your surrender request and told you that you’ll get the fund value after completion of 5 years. (i.e. you have to wait for 1 more year to get your money back).
In this scenario, the fund value will go into discontinuance fund and you will end up losing your life cover. However, there would not be any admin charges, mortality charges etc.
So, after 1 more year, you got your fund value back. Do you know how much tax needs be paid in this case?
The entire fund value amount would be added to your income. You would have to pay tax as per your tax slab. Yes, you heard it right, tax – not on the gains but instead on the entire fund value.
So, first your tax benefits get reversed under Section 80C, if you had availed any. 2nd, you have to pay the tax on the entire surrender value.
Here is the link for your reference from Edelweiss Tokio
What if my fund is performing badly and the fund value is negative? You would still have to pay the taxes on that amount. This is the reality of ULIPs.
You have no choice of coming out (for 5 years) if the fund performance of the ULIP is bad. But if you want to come out, taxation on ULIP surrender is undoubtedly a big mess. That is the tax efficiency of ULIPs when we compare it with mutual funds.
So, whenever you want to invest in ULIPs, always keep this one thing in mind – No matter what happens, you have to way to come out of it before 5 years. And if you really want to come out, then be ready to pay the huge amount of tax. Till then,
Be careful and Happy Investing!