The Finance Bill of 2012 has made it mandatory that the sum assured should be 10 times the annual premium (the earlier limit was five times) for life insurance policies for you to enjoy the tax benefits under Section 80C for investment and under Section 10(10D) on maturity. Even if you have purchased a life insurance product with sum assured of 10 times the premium, what happens to the tax benefit you have taken under Section 80C if you surrender the policy? Is the surrender amount taxable? Buying an insurance product to surrender before maturity may mean taking a big loss on your corpus. But what happens to the tax benefits? Here are some facts that neither your agent, nor your insurer will tell you.

Tax savings on entry: If you do not pay any additional premium after buying a regular premium traditional policy, not only do you not get any surrender value, you will also have to reverse the Section 80C tax savings you have taken. The amount of deduction allowed under Section 80C in the earlier years shall be deemed to be the income of the customer and liable to tax in the year of surrender of policy. It will be a double whammy for you. According to 80C rules, tax savings will have to be reversed if you do not keep single premium policy in force for two years after the date of commencement of the policy or regular premium policy premiums are not paid for two years.

Tax savings on exit: On receipt of surrender or paid-up value, you will not have to pay taxes. This is similar to tax treatment of policy on maturity or death of policyholder as long as the insurance component of the policy is 10 times the premium. But, if you get pathetic GSV, what is the use of it being non-taxable? Why buy a traditional product if you want to surrender it?

ULIP lock-in: For old ULIPs, surrender charges, especially in the first three years, were high. The surrender value would be payable after completion of three policy years. For new ULIPs, if you stop paying premiums before making the mandatory five payments, the proceeds of the discontinued policy  will earn 4%pa interest (the same rate as on your savings account) until the completion of five policy years. You will get funds only after five policy years.
Tax savings on entry and exit: There is a controversy over what is meant by a ULIP less than 80C. It points to definitions given in clause (x) and (xi) of sub-section (2), which defines it as unit-linked insurance plan, 1971 of Unit Trust of India and unit-linked insurance plan of LIC Mutual Fund. Clearly, it means that the ULIPs sold by life insurance companies today are not covered by this definition. If so, by default, the same rules as are applicable to traditional products should apply for tax savings on entry and exit. But, if you get pitiable surrender value for old ULIPs, what is the use of it being non-taxable? Why buy a new ULIP if you plan to surrender since you will have to wait for five policy years anyway.
Savers buy insurance products for investment without thinking, lured by advertisements and push from agents. When they try to surrender, they realise what a trap it is. At that time neither your insurer nor agent will help. You will get a meagre corpus and will have to pay tax on it.

Also, rules of pension product on tax savings on entry and exit are much different than regular life insurance products. Surrender of pension product can be worse than life insurance product surrender.