Unit Linked Insurance Plans (ULIPs) provide a dual benefit of investment and insurance, making them a popular choice for financial planning in India. However, understanding the tax implications on surrender or redemption of ULIPs is crucial for investors to make informed decisions. The taxability of ULIP proceeds depends on factors such as the lock-in period, premium amounts, and whether the policy meets specific tax-exemption criteria under the Income Tax Act. This article explores the tax rules for surrender, conditions for tax-free proceeds, taxation on partial withdrawals, and common mistakes to avoid when filing taxes related to ULIPs.

• ULIP premiums qualify for deductions under Section 80C, subject to eligibility criteria.
• The annual premium must not exceed 10% of the sum assured for policies issued after 1 April 2012.
• ULIPs offer long-term tax advantages, including tax-free maturity proceeds and capital gains exemptions.
• Compared to PPF and ELSS, ULIPs provide dual benefits of insurance and investment.

The taxability of ULIP surrender proceeds depends on whether the surrender occurs within or after the lock-in period. The lock-in period for ULIPs is five years, and premature surrender can attract taxation.

Key tax rules for ULIP surrender:

• Surrender within the lock-in period: If the policy is surrendered before the five-year lock-in period, the proceeds are added to your income and taxed according to your applicable income tax slab.
• Surrender after the lock-in period: Post lock-in, ULIP surrender proceeds are generally tax-free under Section 10(10D), provided the policy complies with tax exemption conditions.
• Policies issued after 1 Feb 2021: For high-value policies with annual premiums exceeding Rs. 2.5 lakh, the surrender proceeds may attract long-term capital gains tax.
• Single-premium policies: Tax rules for surrender proceeds vary based on the premium and sum assured ratio.

ULIP proceeds can be tax-free if they meet specific conditions outlined in the Income Tax Act under Section 10(10D). Investors should carefully evaluate these conditions to benefit from tax exemptions.

Conditions for tax-free ULIP surrender proceeds:

• Compliance with premium-to-sum assured ratio: The annual premium should not exceed 10% of the sum assured for policies issued after 1 April 2012. For older policies, the limit is 20%.
• Lock-in period: The policy must complete the mandatory five-year lock-in period to qualify for tax-free proceeds.
• Premium cap for tax exemption: For policies issued after 1 February 2021, total premiums across all ULIPs should not exceed Rs. 2.5 lakh annually. If they do, gains are taxable under LTCG provisions.
• No deductions claimed: Tax-free proceeds are allowed only if no tax deductions were claimed under Section 80C for the premium payments.

Partial withdrawals from ULIPs are an attractive feature for liquidity, but their taxability depends on the timing and nature of the withdrawal.

Tax implications on partial withdrawals from ULIPs:

• Withdrawals after five years: Partial withdrawals made after the lock-in period are tax-free under Section 10(10D), provided the policy meets exemption conditions.
• Withdrawals before five years: Any withdrawal before the lock-in period is taxable and added to your income, taxed according to your income slab.
• Impact of high-value policies: For policies with annual premiums exceeding Rs. 2.5 lakh issued after 1 February 2021, gains from partial withdrawals are taxable under LTCG.
• Tax-free limit: Withdrawals up to 20% of the fund value are generally tax-free if the policyholder has paid premiums for at least two years.

Incorrect tax filing for ULIP surrender or redemption can lead to penalties or missed benefits. Avoiding common errors ensures compliance and maximises tax savings.

Common mistakes to avoid:

• Ignoring high-value policy rules: Policies issued after 1 February 2021 with premiums exceeding Rs. 2.5 lakh are subject to LTCG tax. Failing to declare such gains may lead to penalties.
• Premature surrender reporting: If the policy is surrendered before the lock-in period, ensure to report the proceeds as income.
• Miscalculating premium-to-sum assured ratio: Policies not meeting the 10% (or 20% for older policies) premium-to-sum assured ratio do not qualify for tax exemption.
• Omitting partial withdrawals: Withdrawals made before the lock-in period are taxable but are often overlooked during tax filing.
• Claiming deductions on ineligible premiums: Ensure that deductions under Section 80C are not claimed for premiums on policies that do not meet exemption criteria.

Understanding the tax implications on surrender and redemption of ULIPs is vital for effective financial planning. While ULIPs offer tax-saving benefits under specific conditions, failure to comply with tax rules can result in additional liabilities. By meeting conditions like lock-in period compliance and premium-to-sum assured ratio, investors can maximise tax efficiency.