All You Wanted To Know About the Taxation of Life Insurance Policies

All You Wanted To Know About the Taxation of Life Insurance Policies

It’s a great idea to secure your family’s future by buying a life insurance policy. However, it pays to know the tax implications as life insurance is a long-term commitment. After all, you don’t want taxes to erode your policy returns, do you?

This article will share the tax treatment of different types of life insurance policies at various stages. It will help you make an informed decision on the type of policy you want to purchase. Also, it will help you adequately meet your tax compliances. So, let’s begin…

Taxation at the time of investing:

When you invest in a life insurance policy, you get a deduction under Section 80C of the Income Tax Act. This benefit is available to all life insurance policies.

This benefit is available if you buy a policy for yourself or your spouse or child. In the case of HUF, this benefit is available if the HUF buys a policy for any member.

Also, this benefit is available to policies purchased from any insurance company registered with the regulatory body IRDAI & not only from LIC, as some people think. Couple of things to note as below:

1. If the policy is issued after April 1, 2012: The deduction is available only if the premium amount is less than 10% of the sum assured.

2. If the policy is issued after April 1, 2013, & covers a person suffering from illness under Section 80DDB or 80U: The deduction is available only if the premium amount is less than 15% of the sum assured.

Taxation on maturity:

Section 10 (10D) of the Income Tax Act clarifies how the insurance policy amount received at maturity will be taxed. The rules are given below:

1. The amount received on death is not taxable.

2. The amount received from the keyman insurance policy is taxable.

3. The amount received on maturity is also exempt as per the following table:

Policy Issue date	​Condition for exemption
​Before April 1 2003	​No condition
​On or after April 1, 2003, but on or before March 31 2012	​Only if the premium amount is less than or equal to 20% of the sum assured.
​On or after April 1, 2012	​Only if the premium amount is less than or equal to 10% of the sum assured.

TDS implications if maturity amount is taxable

An insurer has to deduct TDS @ 5% if the maturity amount is taxable & the amount payable is INR 1,00,000 or more. This TDS is not on the entire maturity amount & is only on the maturity amount’s income component.

Deduction of TDS does not mean that amount is not taxable in your hands. It means that you need to include the income in your tax return. You can also claim the TDS deducted by the insurer.

Keep in mind that this rate is applicable if you have provided your PAN to your insurer. If not, a higher rate of 20% becomes applicable.

Also, in such cases, don’t forget the calculate the advance tax liability & pay advance tax before the end of the year. If you don’t do that, you may have to pay additional interest when filing the return.

Example to help understand better

Let us understand the taxation & TDS implications of maturity with some examples given in the following table:

​Year of Purchase	​Annual Premium	Sum Assured	Premium/ sum assured	Maturity Amount	Taxation of maturity amount	TDS Implication
2000	​4,00,000	10,00,000	40%	​40,00,000	Tax free	No
2006	1,00,000	4,00,000	25%	10,00,000	Taxable	Yes
2014	80,000	10,00,000	8%	5,00,000	Tax Free	No

As you can see, in the first and third case, the TDS implication will not arise since there is no tax liability. In the second case, TDS@5% will apply to the “income component” of the maturity amount since the maturity amount is more than INR 1 lac.

Taxation of ULIP policies – New Amendment in Finance Act, 2021

There has not been a separate taxation provision for ULIPs till now, & it was governed as per the above rules. However, the Finance Act, 2021 has changed the position.

According to the new changes, the maturity amount from ULIP will continue to be exempt as long as the amount of premium is more than INR 2.5 lacs. Maturity proceeds will be taxable for ULIPs exceeding this premium amount. The tax calculation is a bit complicated & is based on the holding period & nature of the underlying funds.

The new provisions are ambiguous on quite a few points & hopefully, the tax position will be evident in the coming days & months.

Taxation of Keyman Insurance policies

Keyman insurance policies are policies bought by the employer to cover the death of its key employees. The employer pays the tax for the premium & receives the maturity amount. The amount paid as a premium qualifies as a business expense and allowed as a deduction from income.

On maturity or death of keyman, Section 10 (10D) does not exempt the payout from these policies in the employer’s hands. So, these policies are taxable & TDS will also apply.

Taxation of Single Premium Policies

The provisions for taxation of single premium policies will apply precisely as the provisions given above. There is no separate provision for taxation of single premium policies.

Conclusion:

Life insurance is a vital piece of the financial planning puzzle. However, it is a long-term commitment also. Knowing the tax implications on the various stages of the policy life cycle can help you make an informed decision on which policy to choose and the risk of tax non-compliance.

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