Is the cash value of mixed life insurance plans taxable?

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It often happens that an insured is not able to continue his life insurance contract. The reason could be anything ranging from lack of funds to better alternatives available in the market. In such a case, if an insured decides to surrender the contract, it is essential to know its tax implications before withdrawing the amount. Here is an overview of the tax treatment of an endowment policy.

Endowment plans are life insurance policies that offer a combination of protection and investment under one plan. In common parlance, a non-ULIP plan is called a staffing plan. They are basically of two types – with profit and without profit. While “with profit” occasionally gives bonuses on company profits, “no profit” plans offer guaranteed returns and do not participate in profits. Within these two types of endowment policies, there are many variations such as repayment plans, guaranteed plans, retirement plans among others.

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Taxability

Note that the cash value of a traditional insurance policy is only tax exempt if the premiums for the first two years have been fully paid. In addition, the period of issue of the policy also determines the tax liability. “If the traditional life insurance policy were issued before March 31, 2003, it would be completely tax-free. If it were issued between April 1, 2003 and March 31, 2012, the surrender value would only be tax free if the sum insured is more than 5 times the amount of the annual premium. If the policy was issued on or at any time after April 1, 2012, the cash value would only be tax free if the sum insured is greater than 10 times the amount of the annual premium, “said Sujit Bangar, founder of Taxbuddy.com.

There are also certain cases where the amount redeemed may be fully taxable. Shailesh Kumar, Partner, Nangia & Co LLP, has stated that any money received under a life insurance policy will be tax exempt, except where such money is received for the following reasons:

1. Key man insurance policy.
2. Deposit with LIC or other specified insurer for the maintenance of a disabled dependent when that dependent dies before the assessed person.
3. Insurance policy issued after April 1, 2003, but before March 31, 2012, when the premium payable for any year during the term of the policy exceeds 20 percent of the sum insured.
4. Insurance policy issued after April 1, 2012 when the premium payable for any year during the term of the policy exceeds 10 percent of the sum insured (provided the policy is issued after April 1, 2013 for insurance – life of a severely disabled person under section 80U or disease or ailment under section 80DDB, 10 percent should be read as 15 percent).

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