Surrender value taxation – must know insurance facts

It doesn’t need iterating that insurance (specially the investment variety) is a super complex product. Read through a product brochure and there are so many ifs and buts attached to any product.

It is just not possible for a layperson to understand and evaluate the product and make an informed decision. Imagine those who bought the policies 10, 15 or 20 years ago.

On top of it, there are tax laws.

Well, I guess there is no point complaining. We will have to learn to navigate through the jungle.

Over the years, I have received several queries from readers and clients who have been saddled with all kinds of policies. Some they have continued to pay premium for, others stopped (as they realised the scam).

I would like to take up one about surrender value taxation of a life insurance policy. 

I have an LIC policy in my name: LIC New Jeevan Anand – Plan 815 (issued in November 2014). I paid only 3 premiums till Nov 2016 and stopped any payments thereafter.

I want to surrender these two policies. The question is will I receive any thing from the policy? Will there be any tax implication – I understand that insurance payouts are tax free?

What is surrender value?

Surrender value is the amount that a person will receive from the insurance company if s/he decides to terminate a life insurance policy (with an investment component such as money back, endowment or ULIP) before its maturity date. Simply put, you are cashing out your policy.

So, if you buy a policy for 20 years but you decide after 10 years that you do not wish to continue with the policy, then you can surrender it and receive a portion of the current value of the policy. Such value is called the surrender value.

Most insurance companies specify the formula that helps you arrive at the surrender value. For example, in case of a traditional policy, it is something like this:

(All premium paid – first year premium + Accrued bonus, if any) * surrender value factor

But it is best to check with the your insurance company for the actual surrender value, which can turn out to be lower.

You should also know that a policy gets a surrender value only after 3 years of premium payment. As per LIC’s website: “Surrender value is payable only after three full years premiums are paid to LIC.”

This fact also helps answer the first question of the reader – will the policy lead to any payout? The simple answer is YES.

The reader has paid 3 premiums and hence there is a value attached to the policy. However, this value can be much lower than what you have paid so far.

Taxation of Surrender Value

The second question is – will the receipt be tax free?

Surrender value can be taxable. But relax! The tax implications occur only under certain conditions.

Let’s take the question about surrender value taxation.
You will NOT have to pay tax on the surrender value of your policy, if:

1. You have paid at least 3 full year premium for your insurance policy.
2. In case of single premium policy, you have held the policy for at least 2 years.
3. In case of ULIPs, this term is minimum 5 years.

However, if the above conditions are not fulfilled, the surrender value taxation applies. You would have to disclose the income as a part of your “Income from other sources” for the financial year in which you received the surrender value and taxes would have to be paid as per your tax bracket.

In the query that I received from our dear reader, the premium has been paid for 3 full years. Hence, there is NO TAX. My reader is safe. 

Pension plans and Surrender Value

In case of PENSION plans, if you surrender before maturity, the entire surrender value is taxable at your current income tax bracket rate.

You would also have to reverse all the tax benefits that you received under Section 80C of the Income Tax Act.

Let’s take a question on this that I had received earlier.

I had a ULIP from AVIVA details as follows-

• Policy: Aviva pension Elite-unit linked
• Date commenced -11/2009
• Plan term – 20 years
• Date redeemed – 06/2016
• Premium – Rs. 4 lakhs p.a. 
• Paid premium 24 lakhs -upto 11/2014 (6 years)(from nri funds)
• Value of redemption Rs. 31.7 lakhs 
• TDS paid Rs. 32,000

What are the tax implications and does one apply indexation to the gains?

VIEW:

Since, this is a pension plan and has been surrendered before maturity, the entire amount is taxable as per income tax bracket applicable in India. 

There are no indexation benefits available on the insurance policy. 

Does a Term plan have surrender value?

Term plans by their nature do not have any surrender value. They continue as long as you pay the premium. In case of death, the sum assured or the insurance cover amount is payable to your dependents or nominees.

If you stop paying the premiums, the policy just stops functioning. You have no life cover. As simple as that.

As a general rule, you should buy only term plans for your life insurance needs. There are better stand alone products to take care of the investment requirements.

Note 1: Insurance premiums paid for self or spouse or children is subject to exemption upto certain limits under Section 80C of Income Tax Act. You do not have to pay tax on such income which you have shown as life insurance premiums. Currently, you can claim premium deduction of upto Rs. 1.5 lacs in any financial year (under old tax regime).

Note 2: It is advisable and recommended that you consult your tax advisor about specific aspects of taxation as applicable to you.