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UNOVEST

A definitive
guide to
Surrender
Value
Taxation
Do you have to pay tax
or not?
July 2017

By:
Vipin Khandelwal
Navi Mumbai Rs. 500
SURRENDER VALUE TAXATION – DO YOU HAVE TO PAY TAX OR NOT?

DISCLAIMER
The information presented in this guide is based on current tax
laws and their interpretation. The author is a SEBI Registered
Investment Adviser. However, he is not registered with IRDA – the
insurance sector regulator.

This guide intends to educate and inform investors. The author


cannot be held responsible for any gain/loss caused to the reader
by acting upon the advice or recommendations.

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SURRENDER VALUE TAXATION – DO YOU HAVE TO PAY TAX OR NOT?

Index
INTRODUCTION

#1 IS THE SURRENDER VALUE OF AN INSURANCE POLICY


TAXABLE?

#2 IS AN INSURANCE POLICY A CAPITAL ASSET?

#3 TDS ON YOUR INSURANCE POLICY PAYOUT

#4 IS THE SURRENDER VALUE OF MY INSURANCE POLICY


TAXABLE?

#5 TRADITIONAL PLANS AND SURRENDER VALUE


TAXATION

#6 PENSION PLANS AND SURRENDER VALUE TAXATION

#7 ULIPS AND SURRENDER VALUE TAXATION

#8 SINGLE PREMIUM PLANS AND SURRENDER VALUE


TAXATION

#9 HOW TO SHOW THE SURRENDER VALUE IN THE INCOME


TAX RETURN?

#10 DO I HAVE TO REVERSE THE TAX BENEFITS TAKEN


UNDER SECTION 80C?

RECAP

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SURRENDER VALUE TAXATION – DO YOU HAVE TO PAY TAX OR NOT?

Introduction
Insurance has been one of the most mis-sold products in the
history of financial services. This has happened more so in the last
2 decades.

As investors realised their mistake, each one of them wanted to get


out of it and make amends as soon as possible.

Thus started the surrender of these unwanted policies.

The product structure itself was difficult to understand and on top


of it the tax laws made the whole process even worse.

Very few understood that the surrender of their policy could attract
the taxman’s attention. And it did!

Over the last few years, I have been receiving several queries about
taxation of surrender values of insurance policies. It is not possible
to answer every query on my blog article or through emails that I
receive.

Hence, I have created this step-by-step guide to help you


understand the various aspects of taxation related to different
types of insurance policies. With this guide, you can know if
you need to pay any tax on the receipts from your
insurance policy.

I look forward to your comments and feedback. Send me an email


to vipin@unovest.co. Happy to hear about how this guide helped
you, if at all.

In your service,
Vipin Khandelwal

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SURRENDER VALUE TAXATION – DO YOU HAVE TO PAY TAX OR NOT?

#1 Is the surrender value of


an Insurance Policy taxable?

The most important principle to be kept in mind to determine the


taxability of your insurance policy is the one provided by Section
10 (10D) of the Income Tax Act, 1961.

The section states that any receipt of amount on maturity of an


insurance policy is not considered as a part of taxable income, if:

a) The insurance policy was bought during April 1, 2003 to


March 31, 2012 and has a Sum Assured equal to or more than
5 times the premium.
b) The insurance policy was bought after April 1, 2012 and has a
Sum Assured equal to or more than 10 times the premium*.

* In case of disability, such Sum Assured is considered as 7.5 times


the premium.

Effectively, if you brought an endowment plan in 2009 with a sum


assured of Rs. 10 lakhs and a yearly premium of Rs. 1 lakh, then on
maturity, any amount received through this policy is tax free under
Section 10 (10 D).

If in the above case, the sum assured is only Rs. 5 lakhs, then the
entire amount becomes taxable.

DEATH BENEFIT IS COMPLETELY TAX-FREE.


It is to be noted that any benefit received on the death of the
insured person is completely tax-free irrespective of any section.

Any other amount received through a policy that does not fall
under the above categorization is subject to tax on maturity.

So, that was taxation on maturity of a life insurance policy.

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SURRENDER VALUE TAXATION – DO YOU HAVE TO PAY TAX OR NOT?

What if you have surrendered your insurance policy?

Surrender means that you give up your policy before the maturity.
For example, if the policy period was 10 years, you decided to give
up the policy after 5 years.

The above Premium vs Sum Assured principle along with other


criteria goes into determining if the surrender value of your policy
is taxable or not.

We will consider the same in further sections of this guide.

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SURRENDER VALUE TAXATION – DO YOU HAVE TO PAY TAX OR NOT?

#2 Is an insurance policy a
capital asset?

Several individuals have regarded an investment-based insurance


policy as a capital asset and hence, treat only the gains as taxable.
Some have also gone as far to index the cost of the policy and
hence calculate and pay taxes on this reduced rate.

In good common sense, this seems to be the fair thing to do. But
unfortunately, as per the current tax laws, this treatment does not
work with insurance policy payouts.

The IT Act of 1961 defines what is a capital asset and the


exemptions applicable.

In my own interpretation, an insurance policy does not figure as a


capital asset. The premium that you pay is for coverage of risk.

When you pay premium on an insurance policy, you have a


guarantee to receive the sum assured or the embedded value in the
policy, in an eventuality of death. This benefit can far exceed the
value of the premiums you have paid.

Unlike an investment in mutual funds, fixed deposits or Postal


Schemes, the insurance premium is not a capital contribution.

Due to this reason, the gains made on insurance policy are not
treated as capital gains. Also, the capital gains rate (long term or
short term) as also indexation is not available.

This understanding is important to ensure that you treat your


payouts correctly from the point of view of taxation.

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SURRENDER VALUE TAXATION – DO YOU HAVE TO PAY TAX OR NOT?

#3 TDS on your Insurance


Policy payout

Since, not all payouts from insurance policies are exempt from tax,
there is a provision for TDS on taxable policy payouts.

In 2014, an amendment to Section 194DA was done to ensure that


TDS or Tax deducted at source is applicable for any insurance
payouts over Rs. 1 lakh. (Source)

For Resident Indians, this TDS is deducted at the rate of 2%.

For Non-Residents, the TDS rate is the effective rate of tax as per
current tax laws, usually 30% in case of NRIs.

Please note that the TDS is only an advance tax withheld by the
insurance company and deposited with the Income Tax
department on your behalf.

When you file your tax returns, you can show this TDS as tax
already paid and pay the balance tax or claim a refund, as the case
may be.

Pro Tip: A TDS on your payout is also an indication that your


insurance policy may not be tax-free. However, you should check
further.

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SURRENDER VALUE TAXATION – DO YOU HAVE TO PAY TAX OR NOT?

#4 Is the Surrender Value of


my insurance policy
taxable?

As mentioned before, the taxability will depend on the facts related


to your insurance policy.

Let’s use a checklist to gather the required facts and then apply
them to your insurance policy. Most of this information is available
in your insurance policy document. Else, you should call up your
agent or the insurance company.

1. Check the Policy Type


a. Traditional (Money Back, Endowment)
b. Pension
c. ULIP
2. Check the Buy Date and which of the following does
it fall into
a. Upto March 31, 2003
b. From April 1, 2003 to March 31, 2012
c. From April 1, 2012
3. Check the premium amount
4. Check Premium Frequency
a. Regular
b. Single
5. Check the Sum Assured
a. Minimum 5 times the premium amount if buy date is
between April 1, 2003 to March 31, 2012
b. Minimum 10 times the premium amount if buy date
after April 1, 2012
6. Premium already paid for (years)
a. 2 years in case of Traditional Plan
7. Policy held for (years)
a. 2 years in case of Traditional

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b. 2 years in case of single premium policy


c. 5 years in case of ULIP or Unit Linked Pension Plan
8. Section 80C benefit taken
a. Yes
b. No

Once you have the information, go to further sections to know


about the applicability for your specific case.

We are going to cover 4 types of cases:

1. Traditional Plans
2. Pension Plans
3. ULIPs
4. Single Premium Plans

Read on.

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#5 Traditional Plans and


Surrender Value taxation

A traditional plan comes in the variants of Endowment and Money


Back policies. LIC is the frontrunner in selling traditional plans.

Typical names of traditional plans are:


1. Jeevan Anand
2. Jeevan Saral
3. Jeevan Shree
4. New Money Back Policy
5. Jeevan Mitra

The value of a traditional plan is not openly available. Only when


you enquire with the insurance company, will you come to know
the current value.

In the case of surrender of traditional plans the guideline is as


follows:

If you have paid 2 or more premiums in a traditional plan, then


any amount received on the surrender of such a policy does not
attract any tax in your hands.

This is subject to the Premium and Sum Assured criteria along


with the start date of the policy as mentioned before.

Sum Assured should be


a. At least 5 times the premium amount if buy date is between
April 1, 2003 to March 31, 2012
b. At least 10 times the premium amount if purchased on or
after April 1, 2012

If your policy does not fulfill this criterion, it is fully taxable in any
case.

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SURRENDER VALUE TAXATION – DO YOU HAVE TO PAY TAX OR NOT?

CASE STUDY:

I have bought LIC – New money back policy in Dec-2013 and I


don’t want to continue now (2016).
I am paying the premium of Rs. 3,200 per month and Sum
Assured is Rs. 5 Lakhs.
If it is to be surrendered, what are the tax implications.

VIEW:

In this case, since the premium has been paid for more than 2
years and the sum assured (Rs. 5 lakhs) is more than 10 times the
annual premium (Rs. 38,400), the surrender value will attract zero
tax.

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SURRENDER VALUE TAXATION – DO YOU HAVE TO PAY TAX OR NOT?

#6 Pension Plans and


Surrender Value taxation

Pension Plans are one of the most ugly products from the
insurance stable. I call them “a wolf in sheep’s clothing”. Let’s see
how.

Some of the common pension plans are:


1. ICICI Pru Life Stage Pension Plan 1 & 2
2. ICICI Pru Life Super Pension Plan
3. HDFC Pension Plus Plan

In case of pension plans, there is typically no Sum Assured and


hence they fail the primary principle of Premium vs Sum Assured.

Even in case of maturity, only 1/3rd of the value of the pension plan
is available tax-free.

The remaining 2/3rd amount has to be compulsorily invested into


an annuity plan with an insurance company. Usually, the same
company, which sold the pension plan to you, also offers the
annuity.

The annuity is a regular payout (yearly, quarterly, monthly)


provided to you and has to be included in your taxable income in
the year of receipt. The tax on such annuity has to be paid as per
your tax bracket.

When you surrender a pension plan, the entire surrender


value becomes taxable as per your current income tax bracket.

CASE STUDY 1:

I received 2 maturity proceeds in FY 2016-17 on the following


ICICI pru life policies:

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1. ICICI Pru Life Time Super Pension policy- acquired in Feb 2007.
The policy matured in Feb 2017 after the vesting period of 10 years.
I had paid 3 annual premiums as per the policy to keep the policy
alive. I received maturity proceeds in Feb 2017 after deducting
30% tax as I am an NRI. Can you advise if the proceeds are tax free
or 1/3 rd tax free?

2. ICICI Pru Life Time Super Pension policy - acquired in July


2007. I surrendered the policy in June 2016 due to financial
reasons before the vesting period of 10 years. I had paid 3 annual
premium to keep the policy alive I received maturity proceeds in
June 2016 after deducting 30% tax as I am an NRI.
Can you advise if the proceeds are tax free or 1/3 rd tax free on this
policy?

VIEW
In case 1, since the pension plan continued till maturity, 1/3rd of
the receipts are tax-free and the remaining 2/3rd have to be
converted to an annuity.

In case 2, since the pension plan was surrendered before maturity,


the entire surrender value is taxable.

CASE STUDY 2:

I have an ICICI Prudential LIFETIME PENSION Policy purchased


in Feb 2004. Policy term is 20 years i.e. its maturity is in 2024. I
want to surrender the policy now (2017). The premium paid value
is approx. Rs. 1.40 lakh and the total current value of the units is
approx. Rs. 2.5 lakh.

What will be the tax liability?

VIEW:
Since it is a pension plan, the entire surrender value of Rs. 2.5
lakhs will be taxable, as per your tax bracket.

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SURRENDER VALUE TAXATION – DO YOU HAVE TO PAY TAX OR NOT?

CASE STUDY 3:

I had a ULIP from AVIVA details as follows-


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 any insurance policy,


including this one.

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SURRENDER VALUE TAXATION – DO YOU HAVE TO PAY TAX OR NOT?

#7 ULIPs and Surrender


Value taxation

ULIP or Unit Linked Insurance Policy is one where the investment


portion is spread across multiple options including equity, bonds,
cash, etc. The policy allocates representative units for each
installment of investment made.

The value of this policy is determined on the basis of the market


value of its holdings and is reflected as a per unit value. And is
available publicly.

Some of the most common names, which individuals have invested


in the past include:
1. Bajaj New Unit Gain Plus
2. ICICI Pru Elite
3. ICICI Pru Lifetime Super
4. LIC Market Plus

In case of surrender of a ULIP, the first criteria to be kept in mind,


is that of Premium vs Sum Assured.

Sum Assured should be


c. At least 5 times the premium amount if buy date is between
April 1, 2003 to March 31, 2012
d. At least 10 times the premium amount if purchased on or
after April 1, 2012

Apart from that, the surrender value payout is tax-free only


if you surrender the ULIP after 5 years of holding.

CASE STUDY:

I’ve two ULIPs before 2012 . All have crosses their lock in periods
and I want to withdraw those investments. The details as below.

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Premium 1 – Rs. 12,000 (Yearly), Sum assured – Rs. 1,20,000 (10


times of premium)
Premium 2 – Rs. 30,000 (Yearly), Sum assured – Rs. 20,00,000
(~70 times of annual premium)

Can you please advise what would be my tax amount on above


policies if surrendered now in 2017?

VIEW:

In both the cases, the minimum 5-year period is exhausted. Also


the Sum Assured is more than 5 times the premium (policy bought
before March 31, 2012), hence the surrender value will be
completely tax free.

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SURRENDER VALUE TAXATION – DO YOU HAVE TO PAY TAX OR NOT?

#8 Single Premium Plans


and Surrender Value
taxation

Single premium policies are those in which you pay just 1 premium
and the policy remains in force for its entire term.

Some of the common names of single premium plans are:


1. Bajaj Allianz Shield Plus Single Premium
2. LIC Endowment Plus – Single Premium
3. ICICI Pru Life Link Wealth – Single Premium

The first condition is that a Single Premium Policy has to be held


for minimum 2 years.

Next, the Premium vs Sum Assured condition has to be checked.

In the earlier years, the Sum Assured on Single Premium policies


was only 1.25 times the Premium amount.

That is where these policies failed to get the tax benefit under
Section 10 (10D).

For example, suppose you bought a single premium policy in


2007 for 10 years, which means it matures in 2017. One time
premium for this plan was Rs. 10 lakhs. Now, if the Sum Assured
in this policy is Rs. 50 lakhs (5 times the premium), there is no tax
liability on it.

However, if the Sum Assured is only Rs. 12.5 lakhs, then the
maturity amount is fully taxable.

Even in case of surrender, the same criterion applies and makes


the entire surrender value taxable as per your tax bracket.

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SURRENDER VALUE TAXATION – DO YOU HAVE TO PAY TAX OR NOT?

CASE STUDY:

Name of Policy: Reliance Insurance Single Premium


Single premium paid: Rs. 1.6 lakhs
Sum Assured: Rs. 2 lakhs
Surrender Value: Rs. 1.85 lakhs
Year of purchase: 2008
Year of surrender: 2016

VIEW:

As we can see, while the insurance policy was held for more than 2
years, it fails to fulfil the basic criteria of Premium vs Sum Assured.
As a result, the entire surrender value is taxable.

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SURRENDER VALUE TAXATION – DO YOU HAVE TO PAY TAX OR NOT?

#9 How to show the


surrender value in the
Income Tax Return?

The Income Tax return should reflect the amount (taxable or not)
that you receive as surrender value.

If the surrender value is taxable, then it should be shown under


“INCOME FROM OTHER SOURCES”.

If the surrender value is NOT taxable, then it should be shown


under schedule of “EXEMPT INCOME”.

Usually, in the case of taxable surrender value, there is a TDS


deduction as well. This TDS is captured under taxes already paid.

You should reduce this TDS from the total tax that you have to pay
to arrive at the balance tax payable or to claim a refund.

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SURRENDER VALUE TAXATION – DO YOU HAVE TO PAY TAX OR NOT?

#10 Do I have to reverse tax


benefits taken under Section
80C?

This can be determined by a simple rule.

If you have held the policy for 5 years from the date of
purchase, then you do not have to reverse any benefits that you
took under Section 80C of the IT Act, 1961.

However, if the holding period is less than 5 years, then you will
have to revise your past income tax returns and pay any additional
taxes, if any, for those years.

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Recap

The following are important things to keep in mind with regards to


taxation of surrender value of an insurance policy:

1. A traditional plan’s surrender value is tax-free if it is held for


more than 2 years and fulfills the relevant Premium vs Sum
Assured criteria.
2. A pension plan’s surrender value is fully taxable at your
marginal rate of tax.
3. A single premium policy which does not fulfill the Premium
vs Sum Assured criteria will be taxed at your marginal rate of
tax (for surrender as well as maturity)
4. You should hold a traditional plan for at least 2 years and a
ULIP for 5 years before the surrender value can become tax-
free.
5. Capital gain benefits as well as indexation benefits are not
available on an insurance policy.
6. The taxable surrender value of insurance policy is to be
shown under Income from other sources in your IT
return.
7. If the value of is exempt, it should be shown under Schedule
of Exempt Income.

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SURRENDER VALUE TAXATION – DO YOU HAVE TO PAY TAX OR NOT?

Comments and Feedback

If you have found this guide useful, please do send in your


comments and feedback to vipin@unovest.co

Many thanks.

Do you know how to calculate the return on your


insurance policy?

Click to know how.

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