No separate tax treatment for surrender value of policy

Published in Mint on 25 August, 2015, Written by Abhishek Bondia

If I surrender my life insurance policy, do I have to pay income tax on the surrender value received? Does the tax treatment differ by plan type?
—Firoz Sheikh

Income tax provisions do not stipulate any separate tax treatment for surrender value of a life insurance policy. If the life insurance cover in a plan is 10 times the annual contribution, the proceeds from that plan are exempt from income tax. Same treatment will apply to surrender value, maturity value and death benefit.
If income tax deduction under section 80C was claimed, then minimum holding period of the plan should be five years. If the plan is surrendered before five years of inception, then the initial deduction will be disallowed. The deduction claimed earlier will become chargeable to tax in the year of surrender of the policy.

Can a life insurance policy be used to take loans?
—Kamal Sinha

Most unit-linked insurance plans and endowment policies can be used to take loans against them. As soon as the policy acquires a surrender value, it becomes eligible as collateral. Generally, the loan offered against a policy is lower than its surrender value. Several insurers provide a loan facility on their own. In other cases, you can approach a lender and offer the policy as collateral.
Term insurance policies typically do not acquire surrender value. So, it is not possible to get a loan against a term insurance plan.

I got two rates for term insurance from the same insurer. The key difference was the duration of the policy. For the longer-term policy, the premium was higher. Shouldn’t it be cheaper?
—Mayank Sethi

Premium is higher for longer-term policies for two key reasons. Firstly, the probability of death increases with age. Therefore, cover for later age is more expensive. For a longer-term policy, insurance companies consider higher age exposure to increase price. Secondly, in most cases, term insurance rates are fixed for the policy duration. Premiums paid in the first and the last years are the same. Coverage for older years is apportioned over the policy paying term.
In several cases, all things remaining the same, a term increase from 10-25 years will almost double the premium.

I was offered a life insurance policy for 15 years. But I was told that I will have to pay only for five years. The remaining period will be free of cost coverage. Is that possible?
—Kumar Gautam

Yes. Under a limited premium payment plan, you have to pay for a shorter period than the coverage period. This does not mean that coverage for the differential period is free. The premium rates for a limited premium payment plan are higher than a regular payment plan. Essentially, the insurer apportions the premium for later years on a smaller term. This works well for those who expect uncertain cash flow.

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