Life Insurance Policy and Income Tax
Once we start working and provide for our family, life insurance comes along as a necessity. Many of us buy a particular life insurance policy on the advice of our peers or our own research. Not long ago, life insurance or simply insurance meant ‘LIC’, and LIC was bought because it brought 80C tax deductions along with it. So, the adage: “LIC for 80C.” Of course, LIC means 80C, rather insurance means 80C. However, as time went by, 80C deductions meant much more than insurance and include PPF, FDR, home loan principal, ELSS, EPF, and many such things. Now insurance has come to mean insurance and 80C is the secondary benefit of it. In these times, buying life insurance has become a necessity and we should know its tax benefits from buying to the realization of its proceeds. This blog post attempts to throw light on the most important tax aspects of life insurance policies.
What is the tax benefit of buying an insurance policy? If you buy an insurance policy and pay a premium in a particular financial year, you are eligible to claim the amount of premium as the deduction from your gross total income (GTI). This way your taxable income is reduced by the amount of premium so claimed as a deduction and you pay lesser tax. This deduction is available in respect of the premium paid by you in respect of the life insurance policy in the name of you, your spouse, or any or all of your children. Unlike school fees payment deductions, there is no limit benefit for only two children in this case. Further, children can be minor or major. This deduction can also be claimed by the HUF in respect of the premium on the life insurance policy of any of its members.
What are the limits on the amount of deductions? The maximum deduction that can be claimed on this is ₹1,50,000/- or the amount of premium whichever is lesser. For instance, if you paid a premium of ₹60,000/- you can claim a deduction of the same amount (provided aggregate 80C deductions don’t cross ₹1,50,000). However, if you paid a premium of ₹1,70,000/-, you could claim a deduction of only ₹1,50,000/-.
Further, the premium for such deduction cannot, in any case, exceed 10% of the sum assured through such policy. For instance, if the sum assured is ₹10,00,000/- and you paid a premium of ₹1,20,000/-, the premium which is eligible for deduction is ₹1,00,000/- and not ₹1,20,000/-. This limit of 10% of sum assured is increased to 15% of the sum assured in case of the persons with disabilities.
The sum assured for this purpose means the actual sum assured and in case you have increased the sum assured during the life of the policy then the least of such sum assured is taken for computation of this benefit. Further, this does not include the amounts of premia paid or bonus received on the policy.
When should the premium be paid? The premium should be paid during the financial year from 1st April of a year to the 31st March of the next year. The insurance companies allow a grace period for payment of premium after the end of the financial year, however, if you pay the premium after the end of a financial year, you can not claim the deduction for the financial year for which you paid premium. In such a case, the deduction is available in the next financial year in which premium is actually paid by you.
What are other conditions? The other conditions are regarding the lock-in period of such insurance policies which are as below:
In case of single premium policies 2 years from the start of the policy
In case of Unit Linked Insurance Policies (ULIP) 5 years from the date of start of the policy
In any other case, 2 years from the start of the policy
In case you fail to continue the policy for the reasons attributable to you like non-payment of premium, then the deductions claimed by you in earlier years shall be taxable as your income in the year in which you have discontinued the policy.
Are the proceeds from insurance policy taxable? Largely, we can say that in most of the situations, the proceeds received on maturity of policy or surrender of the policy or death of the insured person are NOT taxable. However, the taxability depends primarily on the situation as to when the proceeds are received.
In case the proceeds are received by the nominee beneficiaries of the insured person on the death of the insured person, then entire proceeds are tax-free and no TDS is attracted.
In case the proceeds are received in any other circumstances, then its taxability depends upon the condition as to whether the premium paid has exceeded mandated 10% (15% in case of disabled persons) of the sum assured in any of the years during the life of the policy.
In case the premium has exceeded the said 10% (or 15% as the case may be) of the sum assured in any of the years as said above, then entire proceeds are taxable at the time of receipt and TDS shall be done
If above is not true and the premium does not exceed the said limits, then the entire amount of insurance proceeds is tax-free and there shall be no TDS
How is TDS done in case of insurance proceeds?
Whether the insurance proceeds are taxable or not, if the amount of such insurance proceeds is ₹100,000/- or less, then there shall be NO TDS
If the amount exceeds ₹100,000/- and is taxable because of reasons cited above, then TDS at the rate of 20% of the proceeds will be done by the insurer
If the amount exceeds ₹ 100,000/- but it is NOT taxable, then there will be NO TDS
The moral of the story is in order to take full advantage of insurance policy, be known about it fully well.