Taxation on Life Insurance Surrender Value

Surrendering a life insurance policy before maturity gives you a lump sum, but it may be taxable. Here's exactly when tax applies and how much, under the Income-tax Act, 2025, which came into force on 1 April 2026, replacing the Income-tax Act, 1961.

Surrender value means the amount that you get from your insurer if you voluntarily opt out of a life insurance policy before it matures. It will always be less than the maturity benefit that you would have got if you had stayed invested for the entire term of the policy.

For example, if you have a 10 year endowment plan and you want to exit after 5 years, the amount that is paid to you at that point in time by the insurer is your surrender value.

There are two types of surrender value calculated by the insurers: Guaranteed Surrender Value (GSV) is the minimum amount that the insurer is required to pay you on surrender as mentioned in the policy document. It is generally a fixed percentage of the total premiums paid, excluding rider premiums and the first year’s premium. The GSV factor increases with policy tenure.

Special Surrender Value (SSV) is a higher value insurers may offer based on the accrued paid-up value of the policy and prevailing bonus rates. Insurers calculate the SSV at their discretion, and it is generally more favourable than the GSV. The surrender value you actually receive is whichever of the two is higher.

Also read: Endowment Policy - Surrender or Convert to Paid-Up

Surrender proceeds are either exempt or taxable depending upon the conditions of Schedule II, which are also applicable to maturity proceeds – depending upon the date of policy issuance and the premium-to-sum assured ratio or aggregate premium limits.

The table below summaries the key exemption conditions:

Note 1: Death proceeds are unconditionally exempt in all cases, regardless of premium, policy type, or date of issue.

If these conditions are met, the surrender value is exempt under Schedule II.

If not:

• Non-ULIP proceeds are taxed as income from other sources under Section 92(2)(l).
• ULIP proceeds are taxed as capital gains under Section 67(5).

For traditional plans such as endowment or money-back policies, taxability of surrender proceeds depends on whether the policy meets the premium-to-sum-assured conditions under Schedule II. The applicable ratio depends on the date of issue — 20% for policies issued between 2003 and 2012, and 10% for policies issued from 2012 onward (15% if the policy covers a person with disability or specified disease).

If conditions are met, the surrender value is exempt. If not, the taxable amount is the surrender proceeds received minus the premiums paid that have not already been claimed as a deduction, charged as income from other sources, computed per Rule 59 of the Income-tax Rules, 2026.

For Unit Linked Insurance Plans issued on or after 1 February 2021, surrender proceeds are exempt only if both conditions are met under Schedule II.

• The premium in any year does not exceed 10% of the sum assured (15% for disability/disease cases), and
• The aggregate annual premium across all such ULIPs does not exceed ₹2.5 lakh.

If either condition fails, the profit on surrender is taxable as capital gains under Section 67(5), computed per Rule 49 of the Income-tax Rules, 2026 — not as income from other sources. This is an important distinction from non-ULIP policies.

Pension and annuity plan surrenders are treated differently from life insurance surrenders. Amounts standing to your credit in a pension fund — including contributions on which a deduction was previously allowed, plus any accrued interest or bonus — are generally treated as taxable income in the year they are received on surrender, regardless of how long the policy was held. This effectively reverses any deductions previously claimed on those contributions.

Under Section 393(1), of the Income-tax Act, 2025 (corresponding to old Section 194DA), the insurer deducts TDS at 2% on the income component of the payout — that is, 2% of (surrender value minus total premiums paid) — provided:

• The total payout exceeds ₹1 lakh, and
• The proceeds do not qualify for exemption under Schedule II, Sl. No. 2.

This 2% rate has applied since 1 October 2024 (reduced from the earlier 5% rate under old Section 194DA). If the surrender value is fully exempt, no TDS is deducted. If TDS has been deducted and your total income falls below the taxable threshold, you can claim a refund by filing your income tax return.

Under Section 92(2)(l), the taxable amount on surrender of a non-ULIP policy is computed as the proceeds received minus the aggregate premiums paid that have not been claimed as a deduction under any other provision of the Act. In practice, this means premiums you previously claimed as a deduction under Section 123 (the equivalent of old Section 80C) are excluded from this offset — so they are effectively pulled back into the taxable amount when you surrender. The deduction benefit you received earlier is recovered through taxation of the surrender proceeds, rather than through a separate "reversal" entry.

For NRIs, the tax treatment of surrender proceeds mirrors that of residents: if the proceeds don't qualify for exemption under Schedule II, they are taxable in India either as income from other sources (non-ULIP, Section 92(2)(l)) or as capital gains (ULIP, Section 67(5)).

NRIs may claim relief under the agreement for avoidance of double taxation (commonly referenced as DTAA, corresponding to old Section 90) between India and their country of residence, which can reduce or eliminate the Indian tax liability. NRIs will have to submit a Tax Residency Certificate (TRC) along with Form 10F, to the insurer before pay out to claim this relief. The TDS deducted in India can be claimed as a credit against the tax payable in the country of residence as per the terms of the DTAA applicable.

Before surrendering your policy, run through this checklist:

• Exemption eligibility: Does your policy meet the premium-to-sum-assured ratio or aggregate premium cap conditions under Schedule II for full exemption? If not, expect tax either as income from other sources (non-ULIP) or capital gains (ULIP).
• Section 123 deduction impact: If you claimed deductions under Section 123 on premiums paid, surrendering means those premiums are effectively pulled back into your taxable surrender amount.
• TDS exposure: If payout is non-exempt and over ₹1 lakh, expect 2% TDS on the income component, and your slab-rate tax liability on the full taxable proceeds.
• Surrender charges: Insurers charge surrender charges, especially in the early years. These are governed by IRDAI regulations and not by the Income-tax Act. Check your net surrender value after the charges before taking a decision.
• Paid-up policy alternative: If you want to stop paying premiums but want to keep some cover, you may consider converting to a paid-up policy. This avoids triggering tax liability while keeping a reduced sum assured till maturity.
• Policy Loan Alternative: Instead of surrendering outright consider a loan against your policy’s surrender value. A policy loan is not a transfer and will not create a tax liability.
• NRI status: If you are an NRI, you have to submit your TRC and Form 10F to the insurer prior to payout for claiming DTAA relief.

Also Read: Understanding Surrender Value in Life Insurance Policy