If you have taken deduction u/s 80C of the IT Act for the premium payment, in that case , do not surrender the policy within the three/five years of its purchase. Let’s check the Income Tax provisions on surrender of insurance policy –
Case 1 – Surrender of the ULIP, within 3/5 years (claimed benefit under sec 80C)
Aman had bought a ULIP insurance plan for 20,00,000 with an annual premium of 70,000. The objective behind taking this was to meet the 80C – Rs 1 lakh investment exemption from salary. After paying first premium, he had realised that he is trapped in wrong plan and so surrendered the plan and got his money back. Luckily, he had got 50% of first year premium 40,000.
If you surrender your policy between 3-5 years (depending on the type I or II), then entire surrender value gets added to your income in the year of receipt (in this case, you can withdraw 99% of the fund value). If you terminate the contract of insurance , your 80C deductions claimed in the past years is taxed as Income from other sources.
What to do to avoid this?
If one claims deduction u/s 80C, then one should not sell the ULIP units before five years of holding . If one does that the deduction allowed shall be taken as income of the year in which you sell. So Aman has to add 40,000 in the current financial years income.
Section 80C of IT Act
(5) Where, in any previous year, an assessee
(i) terminates his contract of insurance referred to in clause (i) of sub-section (2), by notice to that effect or where the contract ceases to be in force by reason of failure to pay any premium, by not reviving contract of insurance,
(a) in case of any single premium policy, within two years after the date of commencement of insurance; or
(b) in any other case, before premiums have been paid for two years; or
(ii) terminates his participation in any unit-linked insurance plan referred to in clause (x) or clause (xi) of sub-section (2), by notice to that effect or where he ceases to participate by reason of failure to pay any contribution, by not reviving his participation, before contributions in respect of such participation have been paid for five years; or
(a) no deduction shall be allowed to the assessee under sub-section (1) with reference to any of the sums, referred to in clauses (i), (x), (xi) and (xviii) of sub-section (2), paid in such previous year; and
(b) the aggregate amount of the deductions of income so allowed in respect of the previous year or years preceding such previous year, shall be deemed to be the income of the assessee of such previous year and shall be liable to tax in the assessment year relevant to such previous year.
What to do, if you have to surrender after 3 years?
To claim tax benefits and avoid tax on the ULIP surrendered amount, it is better to surrender after 5 years. You can stop paying premium after 3 years and use cover continuance option till 5th year and then surrender the policy.
Case 2 – Surrender of the ULIP, within 3/5 years (not claimed benefit under sec 80C)
Aman had bought a ULIP insurance plan for 20,00,000 with an annual premium of 70,000. He had not taken any deduction under sec 80C of Income Tax Act.
If no deduction was taken u/s 80C on premium , in that case no addition can be made as per provision u/s 80C(5) of the IT Act. So enjoy with the surrender value (even it is quite less than the premium deposited by you).
Case 3 – Surrender of the ULIP, after 3/5 years
Aman paid the premium of the ULIP plan for 3-5 years (depending on the type I or II). And surrendered the ULIP plan after five years period.
The Surrender value of the ULIP plan after 3/5 years (depending on the type I or II) is completely tax-free under 10(10D).
Case 4 – Surrender of Pension Plan
Aman had bought a Pension Plan for 35,00,000 with an annual premium of 75,000. Claimed tax deductions under Income Tax sec 80CCC. And surrendered the ULIP plan after five years period.
The surrender value shall be taxed in the year in which it has surrendered. Therefore, your surrender of pension plan shall be taxed as under
The principal value, plus the bonus or interest credited at the time of surrender will be taxed and added to your total income as income from other source.
If you did not claim deduction u/s 80CCC, then only bonus or interest shall be taxed and added to your total income as income from other source.
Section 80CCC of IT Act
(2) Where any amount standing to the credit of the assessee in a fund, referred to in sub-section (1) in respect of which a deduction has been allowed under sub-section (1), together with the interest or bonus accrued or credited to the assessee’s account, if any, is received by the assessee or his nominee —
(a) on account of the surrender of the annuity plan whether in whole or in part, in any previous year, or
(b) as pension received from the annuity plan,
an amount equal to the whole of the amount referred to in clause (a) or clause (b) shall be deemed to be the income of the assessee or his nominee, as the case may be, in that previous year in which such withdrawal is made or, as the case may be, pension is received, and shall accordingly be chargeable to tax as income of that previous year.