Taxability of ULIP on Surrender

Table of Content

1. What Are ULIP Plans?

2. What Is ULIP Policy Surrender?

3. Tax on ULIP Surrender

4. Conclusion

5. Frequently Asked Questions (FAQs) on Taxability of ULIP on Surrender

Understanding how ULIP surrender is taxed helps you make informed decisions about when and how to exit your policy. Before this, let's know what ULIP Plans are.

What Are ULIP Plans?

A ULIP is a hybrid plan that brings life insurance and market-linked investing under one product. A part of your premium goes toward providing life cover, while the remaining amount is invested in funds you choose: equity, debt, or a mix of both. 

The value of your investment moves with market performance, which makes ULIPs different from traditional insurance with fixed returns. This structure also influences how they are taxed, as the treatment of maturity or surrender proceeds depends on specific rules and conditions. 

What Is ULIP Policy Surrender?

Surrendering a ULIP means voluntarily exiting the plan before it reaches its maturity. In simple words, policy surrender is when the policyholder voluntarily makes the decision to terminate the ULIP and withdraw the investment early. People might surrender their ULIPs due to urgent financial needs, better investment alternatives, low returns, or shifting life priorities. When a ULIP is surrendered, the insurance company pays out the present fund value, post deducting any applicable charges.

ULIPs have a five-year lock-in, which is regulated by the Insurance Regulatory and Development Authority of India (IRDAI). Surrendering the insurance policy before this period might lead to penalties, and the surrender proceeds will be taxable, which could minimise total benefits.

Tax on ULIP Surrender

Surrendering a ULIP can result in tax, and the outcome depends on certain key factors. The exit timing, the date the policy was issued, the premium you make payment of each year, and the level of life cover all play a part. Such rules come from Section 10(10D) 1  of the Income Tax Act, 1961 which decides when ULIP payouts qualify for exemption and when they do not.

As per the tax provisions, ULIP surrender value is tax-exempt only if the policy fulfils all the conditions prescribed under Section 10(10D)—the same conditions that apply to the maturity proceeds. This includes:

• For policies issued on or after 1 April 2012: The annual premium should not be more than 10% of the sum assured for the surrender value to remain exempt.

• For policies issued before 1 April 2012: The premium cap is 20% of the sum assured.

• For ULIPs issued on or after 1 February 2021: The aggregate premium of all ULIPs in a financial year must not exceed ₹2.5 lakh, and the premium of each individual ULIP must be within 10% of the sum assured, for the surrender value to stay exempt.

If any of these conditions are not met, the surrender value is taxable. In such a case, the net gains (surrender payouts less premiums paid) received on surrender are taxed under the head “Income from capital gains” as LTCG under Section 112A at the rate of 12.5% not exceeding the gains of ₹1.25 lakh in a financial year.

Understanding Section 10(10D)

Section 10(10D) of the Income Tax Act, 1961 lays down the conditions under which ULIP maturity or surrender proceeds are exempt from tax. The rules consider how the premium compares to the assured sum and even involve the yearly premium limit of ₹2.5 lakh for policies issued either on or post 1st February 2021. If such conditions are not abided by, the payout becomes taxable. In some uncommon cases, a policy may not qualify as a ULIP for tax purposes, leading to full taxation.

Tax Rules Depending on Lock-In 

Surrender Before 5 Years

Exiting a ULIP before the lock-in of five years generally makes the payout taxable. Section 10(10D) 1 governs tax exemption, and to qualify, the annual premium must not exceed 10% of the sum assured; for policies issued on or after 1st February 2021, the yearly premium must also stay within ₹2.5 lakh.

If these limits are crossed, the surrender amount is added to your income and taxed as capital gains. Any earlier deductions claimed under Section 80C may be reversed, and TDS can be applied. When a policy is discontinued early, its fund value shifts to a Discontinued Policy Fund until the lock-in period finishes.

Surrender After 5 Years

Once the lock-in of five years is over, you are free to exit your ULIP. But the surrender amount is not tax-free automatically. The payout must still meet the conditions laid out as per Section 10(10D) of the Income Tax Act, 1961. If the annual premium stays within 10% of the sum assured and for policies issued on or after 1st February 2021, within the ₹2.5 lakh yearly limit, the entire amount becomes exempt from tax. 

If these conditions aren’t met, the surrender proceeds are added to your income and taxed as capital gains under Section 112A of the Income Tax Act, 1961. Post the lock-in, partial withdrawals are even permitted, and only the ones that meet Section 10(10D) 1 rules enjoy tax-free treatment. 

Tax Rules Based on Policy Issue Date

ULIPs Issued Before 1st February 2021

Policies issued before 1st February 2021 follow the older rules, which do not include the ₹2.5 lakh premium cap. These policies are governed primarily by the earlier conditions under Section 10(10D) of the Income Tax Act, 1961. If they meet the particular conditions of Section 10(10D), particularly the premium not exceeding the limit of 10% of the sum assured for policies issued on or after 1 April 2012, or 20% of the sum assured for policies issued before 1 April 2012, then the surrender proceeds are totally free of tax, regardless of when you surrender the policy.

ULIPs Issued On or After 1st February 2021

For ULIPs issued from 1st February 2021 onwards, the Budget 2021 rules introduced a yearly premium cap of ₹2.5 lakh along with the premiums not exceeding the 10% of the sum assured. If the clubbed premium paid across all such ULIPs surpasses this limit, then the surrender amount is tax free only for the policy which has premium less than Rs 2,50,000 loses complete exemption and is taxed as per capital gains. 

To stay free of tax, the plan must even meet Section 10(10D) conditions. This involves the rule that the premiums must remain within the allowed percentage of the sum assured. 

Conclusion

Surrendering a ULIP comes with clear tax outcomes, and being aware of them assists you in planning better. Exiting before the lock-in of five years usually results in tax liabilities and might even trigger a reversal of deductions claimed earlier as per Section 80C. Withdrawing post the lock-in can offer benefits that are tax-free. However, this is possible only when the policy satisfies certain conditions under Section 10(10D)1 of the Income Tax Act, 1961. Budget 2025 further reinforces that non-exempt ULIPs are taxed according to capital gains and not as income from other sources. 

Before deciding to surrender the policy, it is recommended to assess your financial goals, premium commitments, and the age of your policy. When in doubt, speaking with a financial advisor or your insurer can help you understand charges, taxes, and the best way forward.

 Frequently Asked Questions (FAQs) on Taxability of ULIP on Surrender

1. What Does ULIP Policy Surrender Value Mean?

The surrender value is the amount you get when you make the decision to close your ULIP plan before it reaches maturity. It reflects your fund value post-adjusting for any charges that apply during the exit time.

2. What happens if I surrender my ULIP policy?

When you take the decision to surrender your ULIP, the insurer pays out the fund value. This payout is dependent on the performance of the market of your selected funds. The tax treatment is based on whether you exit before or after the lock-in of the five-year period and whether the policy meets the conditions of Section 10(10D) 1.

3. Is ULIP taxable in 2025?

ULIPs in 2025 are taxable if they don’t meet the exemption rules under Section 10(10D) as per the Income Tax Act, 1961. Non-compliant ULIPs, especially those breaching premium limits, are taxed as capital gains, as clarified in recent budget updates. 

4. Are Tax Benefits Available on Surrendering a ULIP Policy?

Tax benefits are available only when the surrender proceeds qualify for exemption under Section 10(10D) of the Income Tax Act, 1961. If the policy meets the required premium as well as sum-assured conditions, then the payout is free of tax; if not, tax applies.

5. Are ULIPs issued before 1st February, 2021, exempt from surrender tax?

Older ULIPs can still enjoy tax-free surrender treatment, provided they meet the conditions of Section 10(10D) 1 of the Income Tax Act, 1961. The ₹2.5 lakh annual premium cap along with the premiums not exceeding 10% of the sum assured applies just to those policies that are issued on or after 1st February 2021.

6. How to calculate tax on ULIP surrender amount?

   To compute tax, check if the policy meets Section 10(10D) criteria. If it does not, then the surrender value is taxed as capital gains. Identify the premium paid, compare it with the exemption limits, and apply the applicable capital-gains rules based on the policy type and holding period.