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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.
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SURRENDER VALUE TAXATION – DO YOU HAVE TO PAY TAX OR NOT?
Index
INTRODUCTION
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.
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.
In your service,
Vipin Khandelwal
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SURRENDER VALUE TAXATION – DO YOU HAVE TO PAY TAX OR NOT?
If in the above case, the sum assured is only Rs. 5 lakhs, then the
entire amount becomes taxable.
Any other amount received through a policy that does not fall
under the above categorization is subject to tax on maturity.
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SURRENDER VALUE TAXATION – DO YOU HAVE TO PAY TAX OR NOT?
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.
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SURRENDER VALUE TAXATION – DO YOU HAVE TO PAY TAX OR NOT?
#2 Is an insurance policy a
capital asset?
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.
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.
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SURRENDER VALUE TAXATION – DO YOU HAVE TO PAY TAX OR NOT?
Since, not all payouts from insurance policies are exempt from tax,
there is a provision for TDS on taxable policy payouts.
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.
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SURRENDER VALUE TAXATION – DO YOU HAVE TO PAY TAX OR NOT?
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.
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SURRENDER VALUE TAXATION – DO YOU HAVE TO PAY TAX OR NOT?
1. Traditional Plans
2. Pension Plans
3. ULIPs
4. Single Premium Plans
Read on.
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SURRENDER VALUE TAXATION – DO YOU HAVE TO PAY TAX OR NOT?
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:
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?
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.
Even in case of maturity, only 1/3rd of the value of the pension plan
is available tax-free.
CASE STUDY 1:
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SURRENDER VALUE TAXATION – DO YOU HAVE TO PAY TAX OR NOT?
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?
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.
CASE STUDY 2:
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:
What are the tax implications and does one apply indexation to the
gains?
VIEW:
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SURRENDER VALUE TAXATION – DO YOU HAVE TO PAY TAX OR NOT?
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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SURRENDER VALUE TAXATION – DO YOU HAVE TO PAY TAX OR NOT?
VIEW:
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SURRENDER VALUE TAXATION – DO YOU HAVE TO PAY TAX OR NOT?
Single premium policies are those in which you pay just 1 premium
and the policy remains in force for its entire term.
That is where these policies failed to get the tax benefit under
Section 10 (10D).
However, if the Sum Assured is only Rs. 12.5 lakhs, then the
maturity amount is fully taxable.
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SURRENDER VALUE TAXATION – DO YOU HAVE TO PAY TAX OR NOT?
CASE STUDY:
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?
The Income Tax return should reflect the amount (taxable or not)
that you receive as surrender value.
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?
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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SURRENDER VALUE TAXATION – DO YOU HAVE TO PAY TAX OR NOT?
Recap
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SURRENDER VALUE TAXATION – DO YOU HAVE TO PAY TAX OR NOT?
Many thanks.
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