Discontinuance Charges in ULIP

What are Discontinuance Charges?

Discontinuance charges (also called surrender charges or policy discontinuance charges) are penalties imposed by insurance companies when you stop paying premiums or surrender your ULIP policy before completing the mandatory 5-year lock-in period.

These charges compensate insurers for:

• Initial costs like commissions paid to agents
• Administrative and underwriting expenses
• Policy setup and distribution costs

IRDAI prescribed caps (Current Guidelines) for Dos

Year of Discontinuance	Maximum Charge Structure
1st Year	Higher of Rs. 6,000 OR 20% of annual premium
2nd Year	Higher of Rs. 4,000 OR 15% of annual premium
3rd Year	Higher of Rs. 2,000 OR 10% of annual premium
4th Year	Higher of Rs. 1,000 OR 5% of annual premium
5th Year	Higher of Rs. 500 OR 2% of annual premium
After 5 Years	No discontinuance charges

How Discontinuance Charges are Calculated?

Example : If you pay Rs. 50,000 annual premium and discontinue in

• Year 1: Max charge = Higher of (Rs. 6,000 or 20% of ₹50,000) = Rs. 10,000
• Year 2: Max charge = Higher of (Rs. 4,000 or 15% of ₹50,000) = Rs. 7,500
• Year 3: Max charge = Higher of (Rs. 2,000 or 10% of ₹50,000) = Rs. 5,000

What happens when you Discontinue the ULIP?

Before 3 Years

• Life cover ceases immediately
• Fund value (minus discontinuance charges) transferred to Discontinued Policy Fund
• Money locked until completion of 5-year lock-in period
• Earns minimal guaranteed return (currently 4% as per IRDAI)

After 3 Years (but before 5 years)

• Fund value (minus charges) goes to Discontinued Policy Fund
• Can choose to revive policy within 2 years by paying outstanding premiums
• If not revived, receive proceeds after 5-year lock-in period

After 5 Years

• No discontinuance charges
• Immediate surrender allowed
• Receive full fund value

How to avoid Discontinuance Charges?

1. Best Strategy: Complete the 5-Year Lock-in Period, continue paying premiums till 5 years

• After 5 years, no surrender charges apply
• Can withdraw funds or continue investment

2. Convert policy to "paid-up" status

• Stop paying premiums but keep policy active
• Reduced sum assured but no discontinuance charges
• Fund continues to grow with existing corpus

3. Premium Holiday Feature : Some ULIPs offer premium holidays

• Skip premiums for specific periods without penalties
• Policy remains active using existing fund value
• Resume payments when financial situation improves

4. Top-Up Strategy : Take the policy with minimum premium and Use top-up investments in good years

• During difficult times, it help in just paying the minimum premium
• During regular time, Top-ups can be used to increase your investment corpus
• Down side to this is, The Top Up premium will not have much life insurance. Usually the life insurance is just 1.5x of the Top Up amount versus it 10x of the normal premium

5. Policy Assignment : Instead of discontinuing your policy, you can transfer it to someone else or take a loan against it

• Through policy assignment, you sell your policy at its current value, and the new owner continues paying the remaining premiums. Note that tax benefits will not apply if the policy is assigned before completing 5 years
• Alternatively, you can take a loan against your policy if you face an emergency

Smart Strategies to Minimise Impact

Before Buying ULIP

1. Choose Lower Premium: Start with amount you can comfortably pay for 5+ years
2. Flexible Payment Options: Select policies with premium holiday features
3. Research Fund Performance: Choose ULIPs with consistently performing funds

If you must Discontinue

1. Wait for Year 3: If possible, pay at least 3 years of premiums
2. Consider Paid-Up: Better than complete surrender
3. Partial Withdrawal: After 5 years, use partial withdrawals instead of full surrender
4. Revival Option: You have 2 years to revive discontinued policy

Tax Implications of Early Discontinuance

Tax Consequences

• Section 80C Benefits Lost: Tax deductions claimed earlier may be added back to income
• TDS Applicable: Tax deducted at source on surrender value
• Taxed as Income: Surrender proceeds taxed according to your tax slab

Tax-Free Exit

• After 5 Years: ULIP maturity proceeds are tax-free under Section 10(10D)
• Condition: Premium should not exceed 10% of sum assured

Financial Planning Tips

🎯 Emergency Fund : Build emergency corpus before investing in ULIPs (infact before everything else)

🎯 Assess Affordability: Choose premium amounts sustainable for 5+ years

🎯 Regular Review: Monitor fund performance and switch if needed (free switches available)

🎯 Goal Alignment: Match ULIP tenure with your financial goals

Conclusion

Discontinuance charges are significant penalties that can severely impact your returns, especially in early years. The best strategy is to avoid them entirely by:

1. Staying invested for the full 5-year lock-in period
2. Choosing affordable premiums from the start
3. Using paid-up option instead of complete surrender
4. Building emergency funds separately to avoid ULIP withdrawals

Remember: ULIPs are long-term investment products designed for wealth creation over 10-15 years. Early exits not only incur charges but also defeat the purpose of long-term compounding benefits.

💡 Pro Tip: If facing financial difficulties, consult your financial advisor or contact us about premium holiday options, paid-up conversion, or policy assignment (sell or take loan) before considering complete discontinuance.

Regards,

Honvest Team.