Know all about tax in case you surrender or terminate your life insurance policy

A life insurance policy is a long term contract. You buy the policy with a term ranging anywhere from 5 years to 35 years. The policy is intangible and pays a benefit either in case of maturity or death during the term of the plan. However, many times than not, you want to give up your policy before its stipulated tenure. Though you can give up your policy, is there any tax implication which you should know? Yes, in case  you surrender or terminate your life insurance policy before its stipulated tenure, there might be a tax implication. Let’s understand what these implications are and how they work but first, a word on surrender of life insurance plans –

What is surrendering or terminating a life insurance plan?

Surrendering your life insurance policy means giving up the plan before the stipulated time and redeeming the benefits applicable as on that date. Say, if you have a plan for 10 years and you want to end the plan and avail any benefit after the first 5 years itself, it is called surrendering the policy. The value which you get on such surrender is called surrender value.

Taxation of surrender value

The surrender value of a life insurance policy is allowed as a tax-free benefit only if it fulfils the below-mentioned conditions –

  • If it is a traditional plan like endowment, money back, etc., the surrender value would be tax-free if the premiums of the first two years have been fully paid and then the plan is surrendered
  • If it is a single premium traditional plan, the surrender value would be tax-free if the plan is surrendered after the completion of the first two years
  • In case of unit linked insurance plans, the surrender value would be tax-free if the plan is surrendered after the completion of the first five years of the plan

Moreover, the period when the policy was issued also determines the taxability of surrender value. Here’s how –

  • If the policy was issued any time before 31st March 2003, the surrender value would be completely tax-free
  • If the policy was issued between 1st April, 2003 and 31st March 2012, the surrender value would be tax-free only if the sum assured is more than 5 times the amount of annual premium
  • If the policy was issued on or any time after 1st April 2012, the surrender value would be tax-free only if the sum assured is more than 10 times the annual premium amount
  • If the policy was issued on or after 1st April, 2013 and if the insured is disabled according to the definition provided under Section 80U or suffers from an ailment listed under Section 80DDB, the surrender value would be tax-free only if the sum assured is more than 6.67 times the annual premium

If the surrender value meets the above listed criteria, the amount received on surrendering the policy would be tax-free in the hands of the policyholder.

However, if the surrender value does not qualify on the above-listed parameters, there would be dual tax implications. These implications would be as follows –

  1. The premium exemption claimed under Section 80C in the years when the premiums were paid would be reversed. The tax exemptions claimed in the years when premiums were exempted would be not applicable any more. You would, therefore, have to pay additional tax on the exemptions claimed in earlier years
  2. The surrender value received would not be exempted under Section 10 (10D). The amount that you receive as surrender value would be treated as ‘Income from other sources’ and taxed at your existing tax bracket.

Surrender value in case of pension plans

If you have a pension plan and you surrender it, the surrender value would be completely taxable under the head ‘Income from other sources’. There are no conditions which make the surrender value tax-free. Moreover, the premium exemption claimed under Section 80CCC for pension plans would also be reversed. You would have to pay additional tax for tax exemptions availed on pension plan premiums if the plan is surrendered any time before the stipulated maturity date.

So, if you are thinking of surrendering your life insurance policy, first understand the tax implications associated with surrender. Only if your surrender value qualifies for tax exemption should you surrender the plan otherwise you would incur dual tax implications.

Read more about taxation facts about your insurance policy

Read more about tax benefits of life insurance policy

Read more about TDS on life insurance policies

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