Surrender Value Of Life Insurance: Taxable In India?

Surrendering a life insurance policy in India can have tax implications. The taxability of the surrender value depends on the type of life insurance policy and the timing of the surrender. If you surrender a policy before its maturity, you will typically receive a surrender value, which is the amount paid out by the insurer after deducting any applicable charges.

In India, the tax consequences of surrendering a life insurance policy depend on the type of plan held. For traditional life insurance policies, such as endowment or money-back plans, the surrender value is tax-free if premiums have been regularly paid for the first two years of the policy. For single premium life insurance policies, the surrender value is tax-free if the policy has been held for at least two years. For unit-linked insurance plans (ULIPs), the surrender value is tax-free if the policy is surrendered after five years from the purchase date.

It's important to note that the date of policy issuance also determines the taxability of the surrender value. Policies purchased before certain dates, such as March 31, 2003, or April 1, 2012, may have different tax treatments for their surrender values. Additionally, the sum assured and the annual premium amount can also impact the taxability.

When surrendering a life insurance policy in India, it's essential to consider the potential tax implications and consult with a tax advisor to understand the specific rules and regulations that apply to your situation.

Surrendering a life insurance policy before maturity

Surrendering a life insurance policy means terminating the policy before its maturity date. This can be done for various reasons, such as the inability to pay premiums or a change in financial goals. When a policy is surrendered, the policyholder receives the surrender value, which is the accumulated value of the investment portion, minus any applicable charges. The surrender value depends on factors such as the policy's duration, growth, and assets.

In India, the tax implications of surrendering a life insurance policy depend on the type of plan held. If you hold a traditional life insurance policy, such as an endowment or money-back plan, the surrender value is tax-free only if you have regularly paid the premium for the first two years of the policy. For single premium life insurance policies, the surrender value is tax-free if the policy has been held for at least two years from the purchase date. For unit-linked insurance plans (ULIPs), the surrender value is tax-free if the policy is surrendered after five years from the purchase date.

It is important to note that surrendering a life insurance policy may result in a lower payout compared to maintaining the policy until maturity. Additionally, the policyholder will lose the life insurance coverage provided by the policy. Therefore, it is essential to carefully consider the financial implications and impact on long-term financial goals before surrendering a life insurance policy.

• Review the policy documents: Before surrendering your life insurance policy, carefully review the contract, riders, amendments, and premium payment receipts. Look for information about surrender charges, surrender value, and other relevant terms.
• Understand the tax implications: Surrendering a life insurance policy may trigger tax consequences, especially if the surrender value exceeds the total premiums paid. Consult with a tax advisor to understand the potential tax liability and ensure compliance with IRS taxation guidelines.
• Contact the insurer: Get in touch with your life insurance provider's customer service to initiate the surrender process. They will guide you through the necessary steps and provide you with the required paperwork.
• Fill out the necessary paperwork: The insurer will typically provide you with a policy termination form or a surrender request form. Complete these forms and provide all the requested information and documentation.
• Receive the surrender value: After processing your surrender request, the insurer will determine the surrender value based on the policy's terms and pay you the amount, usually via check or direct deposit.
• Consult with financial advisors: Consider consulting a financial advisor to explore alternative options for accessing the cash value of your life insurance policy, such as borrowing against the policy or withdrawing from the cash value. They can also help you make informed decisions about reinvesting the surrender value.
• Weigh the pros and cons: Surrendering a life insurance policy may provide you with a lump sum payout, but it also means giving up the policy's coverage and benefits. Consider your current financial situation, future financial needs, and risk tolerance before making a decision.

Surrender value and its calculation

Surrender value is the amount paid by the insurance company to the policyholder when they decide to terminate the policy before its maturity date. If the policyholder surrenders during the policy tenure, the earnings and savings portion will be paid to them. Surrender charges are deducted based on the terms of the plan.

There are two types of surrender value:

Guaranteed Surrender Value

The guaranteed surrender value is usually mentioned in the brochure and is payable after the completion of 3 years. It is the sum of the total premiums paid, excluding premiums for the first year. It also does not include any additional premium paid for riders and any bonuses you may have been eligible to receive at maturity. The guaranteed surrender value is calculated as the product of the total premiums paid and the surrender value factor (percentage of total premiums paid).

Special Surrender Value

Special surrender value depends on the total sum assured, total premiums paid, policy term, and applicable bonuses. If an individual cannot pay the premiums, the policy becomes a paid-up policy, with the sum assured reduced according to the total premiums paid. On surrendering a paid-up life insurance, the policyholder will receive the special surrender value, calculated by adding the paid-up value to the surrender value factor.

The formula for calculating the special surrender value is:

> Special surrender value = (Initial base sum assured * (Number of premiums paid/Number of premiums payable) + total bonus received) * surrender value factor

The paid-up value is calculated as follows:

> Paid-up value = original sum assured * (No. of premiums paid/No. of premiums payable)

The surrender value of a life insurance policy can be calculated in three steps:

• Determine the cash value of the policy, which includes the premiums paid and any investment gains or losses.
• Determine the surrender charges or penalties, which vary depending on the type of policy, the length of time the policy has been in force, and the number of premiums paid.
• Calculate the surrender value by subtracting the surrender charges or penalties from the cash value of the policy.

Taxability of surrender value

Surrendering a life insurance policy in India can have tax implications. The taxability of the surrender value depends on several factors, including the type of plan, the timing of surrender, and the amount received. Here is a detailed overview of the taxability of surrender value in India:

• Traditional Life Insurance Plans: If you surrender traditional plans like endowment or money-back policies, the surrender value is tax-free only if you have paid the premiums regularly for the first two years of the policy.
• Single Premium Life Insurance Plans: For single-premium policies, the surrender value is tax-free if the policy has been held for at least two years from the purchase date.
• Unit-Linked Insurance Plans (ULIPs): ULIPs have a mandatory lock-in period of five years. If you surrender a ULIP within this period, the gains are taxable as income. However, if you stay invested for more than five years, the gains become tax-free.
• Date of Policy Issue: The taxability of the surrender value also depends on when the policy was issued. Policies purchased before March 31, 2003, are fully exempted from tax on surrender. For policies issued between April 1, 2003, and March 31, 2012, the surrender value is tax-free if the sum assured is at least five times the annual premium. For policies issued on or after April 1, 2012, the sum assured should be at least ten times the annual premium to qualify for tax exemption.
• Disability or Specified Ailments: If the policy was issued on or after April 1, 2013, and the policyholder is disabled as per Section 80U of the Indian Income Tax Act, 1969, or suffers from an ailment listed under Section 80DB, the surrender value is tax-free if the sum assured is at least 6.7 times the annual premium.
• Taxation Rules: If the surrender value is taxable, it is treated as 'income from other sources' and taxed according to the individual's applicable tax slab. The Tax Deducted at Source (TDS) will also apply in such cases.
• Reviving a Surrendered Policy: It is important to note that most ULIP plans allow you to revive them within a certain period after they lapse, usually by paying outstanding premiums with interest.
• Loans Against Surrender Value: You can avail of loans against the surrender value of your life insurance policy. The loan amount can be up to 80%-90% of the surrender value. However, borrowing against the policy in its initial years is not recommended, as the surrender value may be low.
• Impact of Surrender on Benefits: Surrendering a life insurance policy means forfeiting the benefits of the scheme. The policyholder will receive a lower amount than the total premiums paid, and the nominee will not receive any benefit amount if the policyholder passes away after the surrender.

Surrender value and its impact on loans

Surrendering a life insurance policy means terminating the policy before its maturity. When a policyholder surrenders their life insurance policy, they receive a cash surrender value, which is the amount of money paid out by the insurance company. This value is based on the cash value of the policy, which is the component of a permanent life insurance policy that helps build cash value through regular premium payments.

The surrender value of a life insurance policy is generally based on the savings and earnings accumulated in the plan up to the date of surrender. However, the insurance company may deduct a surrender charge, which is a fee for cancelling the policy. This charge can be as high as 10-35% of the policy's cash value and usually decreases over time. After 10 to 15 years, most policies no longer have a surrender charge, and the cash surrender value equals the cash value.

In India, the tax rules for surrendering a life insurance policy depend on the type of plan held. If the policyholder holds a traditional life insurance policy, such as an endowment or money-back plan, the surrender value is tax-free if they have regularly paid the premium for the first two years of the policy. For single premium life insurance policies, the surrender value is tax-free if the policy has been held for at least two years from the purchase date. For unit-linked insurance plans (ULIPs), the surrender value is tax-exempt if the policy is surrendered after five years from the purchase date.

Surrendering a life insurance policy can have an impact on loans taken against the policy. If there is an outstanding loan against the policy's cash value, the insurance company will deduct the loan amount and any interest from the cash surrender value. This will reduce the amount paid out to the policyholder.

It is important to note that surrendering a life insurance policy also means giving up the coverage and benefits offered by the policy. Policyholders should carefully consider their financial goals and needs before deciding to surrender their policy.

Special surrender value

To understand the special surrender value of life insurance, we need to understand the paid-up policy in life insurance. If a person purchases life insurance and is unable to pay the premiums, the policy itself converts into a paid-up policy with the sum assured reduced according to the total premiums paid. On surrendering a paid-up life insurance, the policyholder will receive the special surrender value, which can be estimated by adding the paid-up value to the surrender value factor.

The formula for calculating the special surrender value is:

> Special surrender value = (Initial base sum assured * (Number of premiums paid/Number of premiums payable) + total bonus received) * surrender value factor

The more the number of premiums paid, the more the surrender value.

The surrender value factor is a percentage of the paid-up value plus the bonus. For the first three years, this factor is zero and keeps increasing from the third year onwards. It varies from company to company and depends on factors such as the type of policy, time to maturity of the policy, completed years of the policy, industry practices, and fund performance in particular policies. Not all companies mention surrender value factors in their brochures.

As per the IRDAI mandate, the life insurance companies in India cannot levy surrender charges if the policyholder surrenders the insurance after five years.

Frequently asked questions