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How are life insurance policies taxed?


In a nutshell, Life Insurance is a contract that you enter into with an insurance company. You, the policyholder, make periodic premium payments to the insurance company in exchange for the total amount payable upon the death of the insured (death benefit) and/or at the completion of the coverage period ( maturity benefits).

Tax benefits for life insurance policies

Life insurance policies not only provide benefits at maturity/at death but are also tax deductible under Section 80C and Section 10 (10D) of the Income Tax Act of 1961.

Let’s understand two tax-affecting terms related to life insurance –

Section 80 C

Any resident or non-resident individual may claim a deduction for life insurance premiums paid under Section 80 C until 1.50 lakh per year. This deduction is available along with other qualifying items like PPF, NSC, ELSS, fixed deposit, home loan repayment, tuition payment, contingency fund contribution etc.

You can only claim the 80C waiver for life insurance premiums up to 10% of the sum insured. For any premium paid above 10%, the deductible will not be available. However, for certain individuals classified as disabled or terminally ill, up to 15% of the premium is waived, capped at INR 1.5 lakh per year.

Part 10 (10D)

Section 10 (10D) of the Income Tax Act determines whether the proceeds of your life insurance policy are tax-free. Section 10 (10D) applies to any amount paid under the plan; whether it’s a death benefit, plan maturity, or other bonuses.

One important thing to remember is that death benefits are always tax-free. Maturity benefits (paid based on survival for a certain period of time) are sometimes taxed, based on premiums paid.

For life plans purchased after April 1, 2012, under section 10 (10D), if the annual premium paid is more than 10% of the policy’s premium, the proceeds at maturity term (survival benefit) will be taxed, according to your income tax table. Otherwise, the proceeds will be tax-free.

For life insurance policies issued between April 1, 2003 and March 31, 2012, the premium must be less than 20% of the sum insured to avoid taxation.

For certain individuals who meet the following criteria:

1. Persons who are disabled or severely disabled as defined in Section 80U of the Income Tax Act 1961.

2. Individuals who are sick as defined in Section 80DDB of the Income Tax Act 1961.

3. Maturity benefits are not taxed if the premium does not exceed 15% of the sum insured for plans purchased before April 1, 2013.

Eligibility Criteria for Section 10 (10D) of the Income Tax Act

1. Section 10 (10D) tax deductions are available for life insurance claim payments such as term and maturity benefits, including accrued bonuses.

2. Section 10 (10D) tax deductions apply to all types of life insurance claims.

3. No upper limit applies to tax benefits available under Section 10 (10D) of the Income Tax Act.

4. Deductibles are applicable to both foreign as well as Indian life insurance companies.

ULIP Tax

Section 10 (10D) benefits also apply to any profits accrued from Unit Linked Plans (ULIPs) and Single Premium Life Insurance Policies (if conditions are met). above are met).

To put it quickly, a ULIP is a policy where you pay a premium for a certain number of years (usually around 5 years), which the insurance company invests in you, along with the provision of life insurance ( usually with an insurance amount of 10,000). After the premium payment period ends, there is a holding period (e.g. another 5 years) and then you receive the maturity benefit. So an example of a ULIP is one where you pay 10,000 per year for 5 years and 5 years later the insurance company returns you a sum of 10 lakhs*. If you die within this time frame, your beneficiary will receive an additional death benefit of INR 100,000.

*This amount is for illustrative purposes only, ULIP is linked to equity market and debt market and returns will vary.

Traditionally, ULIP premiums are waived under section 80C, and maturity benefits are also waived, under section 10 (10D).

For ULIPs, however, a new rule was introduced in 2021 that applies to ULIPs purchased on or after February 1, 2021. The rule is simple:

If the annual premium paid to the ULIP is more than INR 2.5 lakh, the profit will not be tax-free. Any taxable gain is considered capital gain (not income tax).

Let us look at some examples –

example 1

For example, let’s say you buy a ULIP on April 2, 2021. Every quarter, you have to pay a premium of INR 65000. You pay for 5 years and for another 5 years the amount is invested by the insurance company who will then pay you a benefit at your maturity of INR 210,000 on April 2, 2031. Contract insurance has a life insurance amount of INR 150,000 (in case you die in those 10 years, your family will receive 150,000).

You can claim 1.5 lakh income tax exemption under the 80C limit, for each year you pay the premium. With a maturity of 210,000, you won’t be able to claim any tax deductions, as your annual premium is 65000×4 = 2.6 lakhs. Since your annual premium paid is over $2,500, your profits will not be exempt and they will be taxed as long-term capital gains (LTCG).

In the unfortunate event that you die within these 10 years and the insurance policy is still valid, your family will receive the death insurance amount of 150,000 completely tax-free. However, at the end of 10 years, when the benefits mature, 210,000 is still taxed on long-term capital gains because the annual premium is more than 2,500,000.

Example 2

Now let’s take another example, where you used ULIP, on April 2, 2021. You pay INR 10,000 per year for 5 years and for another 5 years the money is still invested, until when the insurance company pays the maturity benefit of INR 120,000 on April 2, 2031. Life insurance policy worth INR 50,000 in the event of your death within 10 years of the policy’s validity.

Even though you pay a premium of 1 lakh, you can only claim INR 50,000 to be exempt from income tax under section 80. This is because the life guarantee amount (aka the sum insured) is INR 50,000 and you can only claim 10% of that income tax free for the 5 years you pay the premium.

However, the maturity benefit is completely tax free as the annual premium you pay is less than 2.5 lakhs.

Overall, the separation between insurance and investment is still better than the alternative and offers better returns. A term life policy coupled with a healthy portfolio often provides better returns than any single life policy, while providing a substantial amount of life insurance coverage for your family. . If you value the simplicity and comfort of having your money managed by advisors, investment-related policies can make sense for you, as long as you stay within tax-free limits.

Author: Avinash Ramachandran, COO and Sunil Padasala, Chief Strategy & Innovation Officer, Assurekit

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