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Is Income Tax to Be Paid on ULIP Surrender?

While making an investment, every investor first checks its tax implication. It is important to have at least some tax-saving instruments in your portfolio that allow you to save taxes. However, several investors hastily invest in random tax-savings instruments without keeping their financial goals in mind. Investors who keep their future goals in mind invest in tax-saving instruments like a Unit Linked Insurance Plan (ULIP).

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The meaning of ULIP

ULIP is life insurance that also offers investment opportunities. When you buy one, you get a life cover and an investment in a single plan. Pay premiums similar to any other life insurance. When you pay a premium, it is partly used towards providing you with a life cover and partly invested in funds that you want. You can choose the funds based on the risk and reward you want to achieve from them. When you buy one, there is a lock-in period of five years. After that period, you can get partial withdrawals for free anytime you want. Once you understand the meaning of ULIP, it is important to understand its tax implication.

Tax implication of ULIP

While ULIP has a unique dual benefit factor to it, one reason why several investors buy a ULIP is its tax benefits. The unique structure of the product enables it to offer tax benefits on multiple levels.

When you buy a ULIP, the premiums that you pay for it are available for deductions under Section 80C of the Income Tax Act. The deductions under the section can be claimed for up to Rs 1,50,000 annually.

In case of the sudden demise of the policyholder, the nominee will receive the death benefit. The death benefit is the sum assured or the fund value of the plan, whichever is higher. The death benefit that the nominee receives is exempt from taxes under Section 10 (10D) of the Income Tax Act. It ensures that when you buy one; you create financial security for your loved ones in case of your absence.

While most life insurance policies have no maturity benefits to offer, ULIP works differently. Maturity is not when the lock-in period gets over, but the tenure that is mentioned in your policy. It is mentioned in your ULIP papers. The maturity amount is subjected to tax exemptions under Section 10 (10D) of the Income Tax Act. However, if you want to surrender your plan before its maturity, it is important to understand how it affects the ULIP tax benefits you would receive.

Tax implications on surrendering ULIP

If you are surrendering your ULIP, there are two scenarios. One where you are surrendering before the lock-in period and one where you are surrendering after the lock-in period.

Scenario 1: Before the lock-in period

If you have surrendered your ULIP before the lock-in period, the surrender value that you receive will be treated as income of the financial year in which you received it. It will be added to your gross total income and the income tax will be applicable. The tax that you have to pay depends on the income tax slab that applies to you.

Scenario 2: After the lock-in period

If you surrender your plan after the lock-in period, you can still avail of ULIP tax benefits. The surrender value will be exempt from taxation under Section 10 (10D) of the Income Tax Act, provided certain conditions are met. This means that when you surrender your policy after the lock-in period, the tax benefits of the surrender value are the same as that of the maturity amount.

Even though you receive the tax benefits of your ULIP if you surrender after 5 years, it is advised to hold the investment until it matures. When you surrender beforehand, you lose on returns that you would be additionally earning with compounding. Also, you would have to search for alternative life insurance options, since the life insurance offered through ULIP will also cease to exist when you surrender your policy. ULIP is designed for the long haul, and to gain its maximum benefits, it is important to hold it for so.

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