a definitive guide to surrender value taxation · surrender value taxation – do you have to pay...

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?

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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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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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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 [email protected]. Happy to hear about how this guide helped

you, if at all.

In your service,

Vipin Khandelwal

mailto:[email protected]


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#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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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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#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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#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.

http://incometaxindia.gov.in/Acts/Finance%20Acts/2014/102120000000035210.htm


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#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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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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#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:

http://www.vipinkhandelwal.com/pension-plans-wolf-in-sheeps-clothing/


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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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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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#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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#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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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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#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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#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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Comments and Feedback

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

comments and feedback to [email protected]

Many thanks.

Do you know how to calculate the return on your insurance policy? Click to know how.

mailto:[email protected]

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