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September 25, 2020

Surrendering your LIC policy prematurely? Know tax implications

by shivam jaiswal in Income Tax

Surrendering your LIC policy prematurely? Know tax implications

Life Insurance acts as financial protection for your family in case of your death or a payment made to you on surviving the policy term. In return for this payment, the policy holders make periodic fixed payments to the life insurance company. In certain types of policies, there is an option to get critical illness benefits or create additional protection for your family if you pass away from an accident. A life insurance policy generally provides the following benefits:

  • One of the most important life insurance benefits is that it helps you secure your family’s financial needs, even when you are not around.
  • If you have a spouse, children or parents who are dependent on you, it can be difficult for them to be able to sustain and take care of their expenses in the event of your demise.
  • This is where life insurance plays an important role, the death benefits can help them take care of their expenses and have the financial stability.
  • A life insurance policy also protects your business. Apart from covering your family, there are some life insurance policies that provide coverage to your business.
  • can help settle the debts. During your life, you may avail of a loan to purchase a home, a car, fund your child’s education, or even to repay debts. However, in case you pass away before paying off the loan, the debt will directly fall onto your family members. If you have a life insurance cover, the family can pay off the debt with the sum assured and live a financially independent life.
  • A life insurance policy supports your retirement plan. One can accomplish the goal of having a good retirement fund by investing in good life insurance plans. There are some life insurance policies that provide regular income on a monthly basis.
  • Apart from protection, one of the most significant advantages of life insurance is that it helps you get tax benefits. No matter what type of life insurance policy you buy, you can save taxes. Under Section 80C of the Income Tax Act, the premium paid for life insurance is eligible for deduction up to a maximum amount of Rs 1.5 lakh. Also, the death benefit or maturity is exempted from tax under Section 10(10D).

What do you mean by surrender of a life insurance policy?

  • Surrendering your life insurance policy means giving up the plan before the stipulated time and redeeming the benefits applicable as on that date
  • One may have to surrender one’s policy for various reasons, be it for financial problems or for the availability of better options.
  • Surrendering a policy comes with various strings attached. The surrender process of an insurance policy depends on the kind of policy the policyholder has invested in. If a policyholder surrenders one’s policy before the maturity date/lock-in period, he needs to pay surrender charges.
  • The surrender charges also vary depending on the type of policy, premium paid and the total premium paying term.
  • Surrender value is the amount the policyholder will get from the life insurance company if he decides to exit the policy before maturity.

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What are the tax implications of the amount received on a life insurance policy?

  • Provisions of section 10(10D) of the Income Tax Act exempt any amount received under a life insurance policy.
  • Such amount includes death benefits, maturity benefits and, accrued bonus.
  • The exemption is available on all the forms of life insurance policy claims.
  • The entire amount received under a life insurance policy is exempt under section 10(10D). There is no upper limit applicable to the claim against the life insurance policy.
  • In case of a life insurance policy issued after 1.4.2003 but on or before 31.3.2012 if the premium payable in any year exceeds 20% of the actual sum assured, then the policy proceeds would be taxable in the hands of the insured.
  • For policies issued on or after 1.4.2012, the limit of 20% has been changed to 10%.
  • In case the insured suffers from severe disability or disease as specified by the Income Tax Act and rules and his/her policy was issued on or after 1.4.2013, then for them the limit of 10% will be increased to 15%.
  • If a policy is a Keyman insurance policy then its proceeds are not tax free as per section 10(10D).

Is TDS applicable to payment of life insurance policy proceeds?


As per section 194DA of the Income Tax Act, 1961, any sum received by an insured Indian resident from an insurer under a life insurance policy shall be subject to TDS @ 3.75% (from 14.05.2020) if the said sum is not exempted under section 10(10D). This means that policy proceeds exempted under section 10(10D) will be given to the insured without TDS. There is no need to deduct taxes if the aggregate payable amount is within Rs 1 lakh.

Are there any tax implications if the life insurance policy is surrendered prematurely?

The surrender value of a life insurance policy is allowed as a tax-free benefit only if it fulfils the below-mentioned conditions –

  • If it is a traditional plan like endowment, money back, etc., the surrender value would be tax-free if the premiums of the first 2 years have been fully paid and then the plan is surrendered
  • If it is a single premium traditional plan, the surrender value would be tax-free if the plan is surrendered after the completion of the first 2 years
  • In case of unit linked insurance plans, the surrender value would be tax-free if the plan is surrendered after the completion of the first 5 years of the plan
  • If the policy was issued any time before 31st March 2003, the surrender value would be completely tax-free
  • If the policy was issued between 1st April, 2003 and 31st March 2012, the surrender value would be tax-free only if the sum assured is more than 5 times the amount of annual premium
  • If the policy was issued on or any time after 1st April 2012, the surrender value would be tax-free only if the sum assured is more than 10 times the annual premium amount
  • If the policy was issued on or after 1st April, 2013 and if the insured is disabled according to the definition provided under Section 80U or suffers from an ailment listed under Section 80DDB, the surrender value would be tax-free only if the sum assured is more than 6.67 times the annual premium

If the surrender value meets the above listed criteria, the amount received on surrendering the policy would be tax-free in the hands of the policyholder. However, if the surrender value does not qualify on the above-listed parameters, there would be dual tax implications. These implications would be as follows:

  • The premium exemption claimed under Section 80C in the years when the premiums were paid would be reversed. The tax exemptions claimed in the years when premiums were exempted would be not applicable any more. You would, therefore, have to pay additional tax on the exemptions claimed in earlier years
  • The surrender value received would not be exempted under Section 10 (10D). The amount that you receive as surrender value would be treated as ‘Income from other sources’ and taxed at your existing tax bracket.

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