Cashing out an Indian life-insurance or ULIP policy early, and the tax

The exemption for a life-insurance payout under Section 10(10D) covers both maturity and surrender, but it is conditional. The first condition is the premium-to-sum-assured cap: the premium paid in any year must not have exceeded 10% of the sum assured for a policy issued on or after 1 April 2012 (20% for one issued before that). A policy sold as an investment, with a high premium relative to a small cover, often fails this.

Two newer caps catch high-value policies. A traditional, non-linked policy issued on or after 1 April 2023 loses the exemption if the aggregate annual premium across your such policies exceeds ₹5 lakh. A ULIP issued on or after 1 February 2021 loses it if the aggregate annual premium exceeds ₹2.5 lakh. If your policy fails any applicable condition, the surrender is not tax-free, and the gain is taxable.

The head of income depends on the kind of policy. For a traditional, non-linked policy that fails the conditions, the taxable amount, the surrender value minus the premiums you paid that were not claimed as a deduction, is taxed as income from other sources. For a ULIP that fails the conditions, the gain is treated as capital gains, and where the ULIP is equity-oriented, it is taxed like an equity fund, at 12.5% on long-term gains above the ₹1.25 lakh exemption and 20% on short-term gains for transactions from 23 July 2024.

So a ULIP surrender and a traditional policy surrender are taxed under different heads at different rates, and getting that right matters. A practising CA works out which head applies, the taxable amount after crediting your premiums, and the correct rate, so the surrender is reported properly rather than assumed to be tax-free.

There is a second sting on an early surrender: it can undo the tax benefit you already took. Under Section 80C(5), if you surrender a traditional policy before premiums have been paid for two years, or a ULIP before five years, the Section 80C deductions you claimed in earlier years are added back as income in the year you surrender, and no deduction is allowed for that year. So exiting too early costs you the past relief as well as taxing the gain.

On TDS, the resident rule (Section 194DA, deducting on the income portion) does not apply to you. As a non-resident, the payer deducts under Section 195 on the taxable portion of the surrender at the rate in force, and you can reduce that with a Form 13 lower-deduction certificate or recover any excess on your return. A practising CA lines up the tax, the possible clawback and the TDS before you surrender, so you know the real net figure in advance.