Surrendering a ULIP inside its five-year lock-in does not return your money: the fund value, less a discontinuance charge of at most ₹6,000, moves to a fund earning at least 4% a year and is paid when the lock-in ends. Charges already taken are gone either way, so the test looks forward: continuing wins when the policy, after the charges ahead, ends up worth more than the surrender value in the discontinued fund plus the premiums you stop paying, invested elsewhere. On the ₹1,50,000-a-year policy below, with the discontinued fund at its 4% floor, those premiums would need about 7.8% a year after tax to match paying through to year 5.
What happens if you surrender a ULIP before 5 years?
The ULIP lock-in is five completed years from the policy's start, and until it ends no payout is allowed except on death or another event the policy covers. Surrender inside it, or miss a premium past the grace period, and the insurer deducts a discontinuance charge, moves the rest into a discontinued policy fund and ends the cover. That fund earns at least 4% a year (IRDAI master circular, June 2024), and its only charge is fund management, capped at 0.5% a year.
Archana's ULIP: surrender in year 3 or pay through year 5?
Archana, 34, earns ₹26 lakh a year. In June 2024 she bought a ULIP at ₹1,50,000 a year with ₹15 lakh of cover and has paid three premiums, ₹4,50,000. In October 2026 the fund value is ₹4,10,000; the lock-in ends in June 2029. Her policy takes the maximum discontinuance charge, a 4% premium allocation charge in years 1 to 5 and none after, the 1.35% cap on fund management and about ₹6,000 a year for administration and cover.
The ₹40,000 she is down, ULIP charges plus market movement, is gone on every path. Each figure assumes her funds earn 8% a year before charges (an assumption, not a forecast), to June 2029.
Surrender now, in year 3: 3% of ₹1,50,000 is ₹4,500, above the ₹4,000 cap, so ₹4,06,000 moves into the discontinued policy fund and grows at the 4% minimum to about ₹4,50,800. Her cover ends today; she keeps the ₹3,00,000 of premiums due in 2027 and 2028.
Stop paying in year 4: if she skips the June 2027 premium, her funds stay invested and her cover runs until the 30-day grace period ends. A ₹2,000 discontinuance charge (2% is ₹3,000, capped) then comes off a fund of about ₹4,25,700, and the rest earns 4%, about ₹4,56,700. She keeps the ₹3,00,000 too.
Pay through year 5: she pays the ₹3,00,000, of which ₹2,88,000 reaches her funds after the allocation charge, keeps the cover, and the fund is about ₹7,86,700 after charges, hers to take from June 2029.
Surrendering now matches that only if the ₹3,00,000 she keeps earns about 7.8% a year after tax, since her policy payout is tax-free; stopping in year 4 needs about 6.5%, as her fund stays invested nine more months. Both assume the discontinued fund earns only its 4% floor; it usually earns more, varying by insurer, and at 5% the returns needed fall to about 5.3% and 4.7%. A replacement term plan's premium comes out of the outside return.
After June 2029 her charges get lighter, the case for keeping the policy past the lock-in: the allocation charge ends, and IRDAI's 2024 cap on yield lost to charges other than cover falls from 4% a year at five years to 2.25% from fifteen.
What are ULIP discontinuance charges each year?
| Yearly premium | Year 1 | Year 2 | Year 3 | Year 4 | Year 5 on | Year 3 as share of premium |
|---|---|---|---|---|---|---|
| ₹50,000 | ₹3,000 | ₹2,000 | ₹1,500 | ₹1,000 | Nil | 3% |
| ₹1,50,000 | ₹6,000 | ₹5,000 | ₹4,000 | ₹2,000 | Nil | about 2.7% |
| ₹3,00,000 | ₹6,000 | ₹5,000 | ₹4,000 | ₹2,000 | Nil | about 1.3% |
These are IRDAI's maximums (Insurance Products Regulations, 2024): a percentage of one year's premium or the fund value, whichever is lower, up to the rupee figures shown, which apply whenever the fund holds at least one year's premium. Insurers may charge less. Fixed in rupees, the caps shrink as a share of larger premiums (last column).
Is ULIP surrender value taxable?
Archana's payout is tax-free under section 10(10D) of the 1961 Act: her premium is a tenth of her cover and below ₹2,50,000 a year. For ULIPs issued from 1 February 2021, once yearly premiums on all such ULIPs together pass ₹2,50,000, the policies that take the total past it lose the exemption. Their gain is taxed as a capital gain: 12.5% on gains above ₹1.25 lakh a year in an equity-oriented fund held over a year (rates since July 2024), and other funds are taxed differently. Where cover is below 10 times the yearly premium, which IRDAI's 2024 rules allow down to 7 times for buyers under 50, the gain is taxed whatever the premium. A death payout stays tax-free. In the old regime, 80C deductions claimed on the premiums are added back to your income if the policy ends before two years' premiums are paid (section 80C(5) of the 1961 Act).
What should you check before you stop paying?
Archana's ₹15 lakh of cover is far below the 10 to 15 times income rule of thumb in the insurance planning guide: ₹2.6 crore to ₹3.9 crore at ₹26 lakh. Stopping before a term plan is issued leaves the family uncovered meanwhile. Endowment policy vs term insurance works out term plus investing; five questions on cost apply to a policy you hold.
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This is general information for salaried individuals in India, not personalised financial advice.
