Surrender Value of ULIP Policy

What is a ULIP?

A ULIP stands for Unit Linked Insurance Plan. It is a financial product that combines life insurance with investment benefits. It essentially puts your money to work in two ways:

• Life Insurance: A portion of your premium goes towards life coverage, just like a regular life insurance policy. This provides financial security for your family in case of your unfortunate demise.

• Investment: The remaining part of your premium is invested in market-linked instruments like stocks or bonds, similar to mutual funds. The investment units you get have a value known as Net Asset Value (NAV), which fluctuates with the market performance.

What is the Surrender of ULIP Policy?

Surrendering a ULIP policy means terminating it before its maturity date. This involves stopping premium payments and cashing out the policy's value, which typically includes the fund value minus any charges or penalties.

ULIPs (Unit Linked Insurance Plans) come with a mandatory lock-in period of 5 years set by IRDAI (Insurance Regulatory and Development Authority of India). You can surrender your ULIP plan before and after this lock-in period in the following two ways: 

1. Surrender Before the Lock-in Period (Less than 5 years):

   • Surrender Possible: You can surrender your policy before the 5-year lock-in period, but it is financially disadvantageous.

   • Discontinuation Charges: Insurers deduct discontinuation charges from the accumulated amount in your policy. These charges are typically a percentage of the premiums paid and can be significant.

   • Money in Discontinued Policy (DP) Fund: The remaining amount (after charge deduction) goes into a Discontinued Policy (DP) fund. It earns a guaranteed interest rate (currently 4% set by IRDAI) until the lock-in period ends.

   • Access to Surrender Value: You will not receive the money immediately. You will get it only after the 5-year lock-in period ends, along with the interest earned in the DP fund.

   • Life Cover Ends: The life insurance component of your ULIP ceases to exist once you surrender.

   

2. Surrender After the Lock-in Period (5 years and beyond):

   • Surrender More Favorable: Surrendering after 5 years is financially better compared to before.

   • No Discontinuation Charges: Insurers typically waive discontinuation charges after the lock-in period.

   • Surrender Value: You receive the fund value of your policy on the date of surrender. This represents the current value of your accumulated units.

   • Tax Implications: The maturity benefit from ULIPs after 5 years is generally tax-free under specific conditions.

Surrender Value of a ULIP Policy

The formula to estimate the ULIP surrender charges is mentioned below:

Surrender Value= Fund Value − Surrender Charges/ Discontinuance Charges

• Fund value is calculated as total units under the policy multiplied by the NAV of the chosen fund.

• Charges vary by ULIPs, impacting the residual investment returns even in favourable market conditions.

• Risk cover stops upon surrender request; surrender value is paid at the lock-in period's end.

• On surrender, discontinuance charges are deducted, and the remaining fund value goes to a Discontinued Policy fund.

• Funds remain there until the lock-in period concludes, possibly incurring a fund management fee up to 0.5% and earning minimum 4% interest annually.

• Surrendered amounts are taxed as income per your tax slab.

• Surrender value is subject to TDS (Tax Deducted at Source).

ULIP Policy Surrender Rules

There are some key things to consider about surrendering a ULIP policy:

• Lock-in Period: ULIPs have a mandatory lock-in period of 5 years. If you surrender during this period, you will receive a lower surrender value due to discontinuance charges. The insurer deducts these charges from your accumulated amount and parks the money in a discontinuance policy (DP) fund. You only get this money after the lock-in period ends, typically earning a minimal interest rate.

• Surrender Value: The surrender value is the amount you get after surrendering the policy. It is based on the investment portion's accumulated value minus applicable charges. These charges can be lower or even zero if you surrender after the lock-in period.

• Charges:  These can include discontinuance charges (during lock-in period), surrender charges (after lock-in period), and allocation charges.

• Tax implications:  The tax treatment of the surrender value depends on the number of years the policy has been in effect.

• Loss of Benefits: By surrendering, you lose out on the life insurance cover and the potential for long-term growth through market investments. ULIPs are designed for the long term, so early surrender might not give you the returns you expected.

Tax Implications of ULIP Policy Surrender

The tax treatment of surrendering a ULIP policy in India depends on when you surrender it:

• Surrender Before 5 years:  This is considered premature surrender and attracts a penalty. The surrender value received is added to your income and taxed according to your income tax slab rate.  There may also be Tax Deducted at Source (TDS) applied.

• Surrender After 5 years: After the lock-in period, there are no surrender charges. The entire surrender value is tax-free.  However, there's a caveat:

  • If you claimed tax deductions under Section 80C for the premiums paid, you may have to pay tax on the gains accrued during the policy term.

When Should You Surrender Your ULIP Policy?

In general, surrendering a ULIP is not recommended unless absolutely necessary. It is an insurance product with an investment component, and it is designed for the long term. Surrendering early means you forgo the potential benefits of market growth and lose out on insurance coverage.

Some of the situations where surrendering a ULIP might be considered are as follows:

• Financial emergency: If you have an urgent need for money, surrendering a ULIP may be your only option.

• Better investment opportunity: If you have a chance to invest in something with a demonstrably higher return potential, then surrendering the ULIP could be considered.

Revival of a Surrendered ULIP Policy

In most cases, yes, you can revive a surrendered ULIP policy, but there are some conditions to consider:

• Time Limit: Generally, insurance companies allow revival within two years of surrendering the policy.

• Payments: You will need to pay all the missed premiums along with any interest charges levied by the insurer.

• Benefits Renewal: The life insurance coverage and investment benefits will be reinstated upon successful revival.

Sum It Up

The surrender value of a ULIP policy is the amount you get if you decide to end the policy early. It depends on how long you have had the policy and the premiums you have paid, with deductions for charges. It is important to know because it affects how much money you'll get back if you decide to surrender the policy before it's supposed to end.