Mentioning Life Insurance For Tax Exemption: Can I?

Life insurance policies are a great way to ensure financial security for your loved ones in the event of your untimely death. They also offer tax benefits, which can be categorised into deductions and exemptions. While both help reduce tax liability, they have different applicability. Tax deductions allow policyholders to save tax by reducing expenses/investments from their Gross Total Income. The life or term insurance premiums paid are eligible for tax deductions under section 80C. A maximum of 1.5 lakhs can be saved each year as per the Income Tax Act, 1961. These benefits include premiums paid for policies bought for a spouse or children. Tax exemptions, on the other hand, are a part of your income that is not subject to tax and can be excluded from your total income. Tax exemptions are applicable to payouts or proceeds from the policy and fall under section 10 (10D) of the Income Tax Act.

Life insurance tax benefits in India

Life insurance policies in India offer financial security and significant tax benefits. Here is a comprehensive guide to the tax benefits of life insurance policies in India.

Deductions and Exemptions

The tax benefits of life insurance policies can be categorised into deductions and exemptions. While both reduce your tax liability, they have different applicability.

Tax Deductions

The Income Tax Act allows policyholders to reduce their tax liability by lowering their Gross Total Income. The premiums paid for life or term insurance are eligible for tax deductions under Section 80C. A maximum deduction of Rs. 1.5 lakh per year is permitted under the Income Tax Act, 1961. This includes premiums paid for policies covering a spouse or children.

Tax Exemptions

Tax exemptions refer to a portion of your income that is not subject to tax and can be excluded from your total income. Tax exemptions are applicable to payouts or proceeds from the policy and fall under Section 10 (10D) of the Income Tax Act.

Phases of Tax Benefits

You can avail of tax benefits at different stages of the life insurance policy.

Entry Advantage

At the entry stage, you are eligible for tax deductions under Sections 80C (life insurance), 80CCC (pension plans), and 80D (health insurance) of the Income Tax Act.

Earnings Advantage

Your investment in the life insurance policy will grow over time, and this growth is currently not subject to tax.

Exclusive Switching Advantage

Switches between different investments, such as equity, debt, or other funds, are not currently taxable.

Exit Advantage

The payouts or proceeds from the policy are eligible for tax exemptions under Section 10(10D) of the Income Tax Act, 1961. However, certain terms and conditions must be met.

Tax Benefits by Section

Now, let's look at the different sections of the Income Tax Act, 1961, and their corresponding tax benefits.

Section 80C

Under this section, policyholders can claim a maximum deduction of Rs. 1.5 lakh per year for premiums paid towards life insurance policies. This is also applicable to policies taken for spouses, children, and parents.

Section 10(10D)

This section provides tax exemptions on proceeds or payouts upon the maturity or surrender of the life insurance policy. It typically applies to death and maturity benefits, provided the policy satisfies the conditions laid down in this section.

Section 80CCC

This section allows tax deductions for payments made towards specified retirement or pension plans, with a maximum deduction of Rs. 1.5 lakh per year. If the policyholder surrenders the pension plan, the amount received is taxable as income if a deduction was previously claimed.

Section 80CCD(1)

This section limits the maximum deduction under Sections 80C, 80CCC, and 80CCD(1) to Rs. 1.5 lakh per financial year.

Section 80D

Section 80D offers tax deductions on health insurance premiums. The maximum deduction is Rs. 25,000 per year, which can increase to Rs. 1,00,000 if the insured or their parents are above 60 years of age. Additionally, Rs. 5000 worth of tax deduction can be claimed for yearly preventive healthcare expenses, subject to the threshold limit.

Riders and Their Benefits

Riders are add-ons to a policy that enhance its coverage. They also come with additional tax benefits.

Critical Illness Rider

If you opt for a critical illness rider with your health insurance plan, you can claim a tax deduction on the health insurance premium paid under Section 80D. The maximum deduction is Rs. 25,000 per year, which can increase to Rs. 1,00,000 per year for senior citizens.

Return of Premium Rider

Choosing this option increases your premium amount and allows you to avail of more tax benefits under Section 80C of the Income Tax Act.

TDS on Life Insurance Policy

Tax Deducted at Source (TDS) is applicable on life insurance policies under certain conditions.

• For payouts above Rs. 1 lakh from a life insurance plan that is not exempted from tax under Section 10(10D), the insurance company must deduct 1% TDS while making payments or transferring proceeds, including bonuses.
• If the proceeds do not exceed Rs. 1 lakh, TDS will not be deducted, but the income received is fully taxable. The TDS claim can be made while filing income tax returns.
• On life insurance policy payouts made on or after October 1, 2019, TDS deducted shall be 5% of the net proceeds (payouts less premiums paid) or income from the policy, as per the Union Budget of 2019.
• There are exemptions to TDS deduction under Section 194DA, such as amounts received under Sections 80DD(3) or 80DDA(3), policies purchased between April 1, 2003, and March 31, 2012, with premiums not exceeding 20% of the total sum assured, and policies purchased after April 1, 2012, with premiums not exceeding 10% of the sum assured.

GST on Life Insurance Policy

Before the introduction of Goods and Services Tax (GST), policyholders paid a 15% service tax, which included the Basic Service Tax, Swachh Bharat Cess, and Krishi Kalyan Cess. After GST was implemented, a uniform GST rate of 18% is charged on term insurance premiums. For other insurance products, insurance companies have the option to charge GST at the rates mentioned in the GST Law.

Eligibility Criteria to Claim Tax Benefits

Hindu Undivided Families (HUFs) and individuals can claim deductions and exemptions to save taxes legally. These can be claimed on premium amounts paid and on the receipt of maturity proceeds or any other income from the policy. These benefits help reduce the overall tax liability of policyholders.

Important Considerations

While tax benefits are an important aspect of life insurance policies, they should not be the sole criterion for purchasing a policy. It is essential to consider your goals, affordability, personal circumstances, income, and other factors before making a decision. Compare different policies, review the terms and conditions, and seek clarification on any questions you may have.

Tax deductions and exemptions

Life insurance policies can provide financial security for your family in the event of your death, and also offer tax benefits. These benefits can be categorised into deductions and exemptions. While both help reduce your tax liability, they have different applications.

Tax Deductions

The Income Tax Act allows policyholders to save tax by reducing expenses/investments from their Gross Total Income. The life or term insurance premiums paid are eligible for tax deductions under section 80C. A maximum of Rs. 1.5 lakhs can be saved each year as per the Income Tax Act, 1961. These benefits include premiums paid for policies bought for a spouse or children.

Tax Exemptions

This is a part of your income that is not subject to tax and can be excluded from your total income. Tax exemptions are applicable to payouts or proceeds from the policy. They fall under section 10 (10D) of the Income Tax Act.

Phase 1: Entry Advantage

In this stage, you are eligible for tax deductions under sections 80C, 80CCC and 80D of the Income Tax Act. Section 80C is for life insurance, 80CCC is for pension plans, and 80D is for health insurance.

Phase 2: Earnings Advantage

Your investment in the life insurance policy will grow over time and is tax-free (subject to conditions).

Phase 3: Exclusive Switching Advantage

If you want to make a switch between different investments, these switches can be across equity, debt or other funds and are not currently taxable.

Phase 4: Exit Advantage

The payouts or proceeds from the policy are eligible for tax exemptions under section 10(10D) of the Income Tax Act 1961. However, there are certain terms and conditions that must be followed.

Other Considerations

It is important to note that the tax benefits should not be the only reason for purchasing a life insurance policy. You must also consider different aspects of the plan, including the tenure of the policy, the premium payable, policy inclusions and exclusions, and the implications of premium default. Additionally, you should compare different policies, go through the terms and conditions, and ask any questions you may have before making a decision.

Tax liability of single premium insurance policies

Single-premium insurance policies are subject to tax liability in certain situations. Here's what you need to consider:

• Taxability: Maturity proceeds from single-premium life insurance policies are generally not exempt from taxation. If the premium exceeds 10% of the sum assured, the difference between the maturity value and the premium paid is taxable. This is outlined in Section 194DA, which mandates a 5% tax deduction at the source on the payment made for life insurance policies.
• Deductions under Section 80C: Life insurance premiums paid for yourself, your spouse, or your children are eligible for tax deductions under Section 80C of the Income Tax Act, 1961. This applies to policies purchased from insurers approved by the Insurance Regulatory and Development Authority of India (IRDAI). The deduction is allowed up to a limit of Rs. 1.5 lakh per year.
• Exemptions under Section 10(10D): For policies issued after April 1, 2012, if the premium paid during any year does not exceed 10% of the sum assured, the maturity proceeds are fully exempt from tax under Section 10(10D). This exemption also applies to any bonus amounts received.
• TDS on life insurance policies: If the maturity amount received from a life insurance policy is more than Rs. 1 lakh and is not covered by an exemption under Section 10(10D), the insurer is required to deduct TDS at a rate of 5% before making the payment. If the amount is less than Rs. 1 lakh, no TDS is deducted, but the entire amount received is taxable.
• Example: Consider an individual who took out a single-premium insurance policy with a maturity value of Rs. 1,10,000 and paid a premium of Rs. 45,000. Since the premium exceeded 10% of the sum assured, the maturity proceeds are taxable and not entitled to exemption under Section 10(10D). Upon surrendering the policy at maturity, the insurance company deducted TDS at 5% on the net maturity proceeds (Rs. 65,000), resulting in a net payment of Rs. 61,750.
• ULIPs: For Unit Linked Insurance Plans (ULIPs), tax benefits are only available if the policy is continued for at least five years. If the policy is discontinued before five years, the tax deduction claimed in previous years will be considered income for the year of termination.
• Tax planning: While tax benefits are an important consideration when purchasing life insurance, they should not be the sole reason for buying a policy. It is crucial to assess your financial needs and choose a policy with adequate coverage, features, and inclusions to protect your loved ones financially.

Tax on insurance payouts

Life insurance policies offer financial security and tax benefits. The tax benefits of a life insurance policy can be categorised into deductions and exemptions.

Deductions

The premium you pay for your life insurance policy is eligible for deductions under Section 80C of the Income Tax Act 1961. This includes premiums paid for policies bought for a spouse or child. An individual can claim a deduction of up to Rs. 1.5 lakh or $1,700 annually under Section 80C.

Exemptions

Exemptions are based on the date of issuance of the policy and conditions mentioned under Section 10(10D) of the Income Tax Act. The exemptions apply to the insurance payouts and are a crucial part of the life insurance tax benefits.

For policies issued after 31st March 2012, the premium paid during any particular year cannot be more than 10% of the sum assured. For policies issued between 1st April 2003 and 31st March 2012, the premium paid during any particular year cannot be more than 20% of the sum assured.

The money received by the policyholder or their nominee at the time of maturity or as a bonus is entirely exempt from income tax under Section 10(10D).

According to the Union Budget 2023, payouts from life insurance policies (excluding ULIPs) issued after April 1, 2023, will be taxable if the total annual premium exceeds Rs. 5 lakhs or $6,100.

If the amount received from a life insurance policy is more than Rs. 1 lakh or $1,200 on policies not covered under an exemption under Section 10(10D), then TDS (tax deducted at source) at 5% shall be deducted by the insurer before making this payment. TDS will also be deducted on bonus payments.

If the amount received is less than Rs. 1,00,000, no TDS shall be deducted, but the amount received shall be fully taxable for you. You can claim credit for the TDS deducted in your Income Tax Return.

Ownership Transfer

To avoid taxation on life insurance proceeds, you can transfer ownership of your policy to another person or entity. This must be done at least three years before your death, or the proceeds will be subject to federal estate tax.

Life Insurance Trusts

Another way to avoid taxation on life insurance proceeds is to create an irrevocable life insurance trust (ILIT). The policy is held in trust, and the proceeds are not included as part of your estate.

Tax benefits on riders of life insurance

Life insurance riders are additional coverage that "ride alongside" your policy. They can be added to both term and permanent life insurance policies, depending on the insurer and the policy chosen. Riders can be added before or after the policy is issued, but this depends on the specific rider rules, which vary from company to company.

Critical Illness Rider

This rider provides a benefit if the policyholder is diagnosed with a critical illness listed in the policy document, such as cancer, stroke, heart attack, or kidney failure. The rider benefit is paid out, and the premium and benefit cease thereafter. This rider can act as an income replacement plan, helping cover medical and household expenses.

Accidental Death Benefit Rider

This rider increases the payout to beneficiaries if the insured dies due to an accident. The insurer pays double the sum assured to the nominee in such cases. This rider is sometimes referred to as a "double indemnity" rider.

Waiver of Premium Rider

The waiver of premium rider ensures that your life insurance policy remains active even if you are unable to pay premiums due to disability or injury. While future premiums are waived, the policy benefits continue.

Long-Term Care Rider

The long-term care rider is typically available on permanent life insurance policies. It allows early access to the death benefit if the insured becomes unable to perform daily living tasks due to a chronic illness. The money received can be used to cover long-term care expenses. There are two types: reimbursement riders and indemnity riders.

Return-of-Premium Rider

The return-of-premium rider refunds some or all of the premium payments if the policyholder outlives the term of the life insurance policy. However, this rider can significantly increase the cost of the premium.

Accelerated Death Benefit Rider

This rider allows early access to part or all of the death benefit if the insured is diagnosed with a terminal illness. While there are usually no restrictions on how the money is used, it can help cover medical treatments and care. This rider is typically included at no additional cost, but there may be a fee to access the benefit.

Disability Income Rider

The disability income rider provides monthly payments to the policyholder if they become disabled and unable to work for a specific period. The payouts are usually a percentage of the total policy's coverage amount.

Family Income Benefit Rider

The family income benefit rider provides monthly payments to the beneficiaries in the event of the policyholder's death.

Tax Benefits on Life Insurance Riders

Life insurance riders generally enjoy the same tax benefits as the basic policy, in accordance with prevailing tax rules. For example, in India, riders are subject to tax benefits under Section 80C and Section 10(10D) of the Income Tax Act. However, there are certain stipulations. The premium for health-related or critical illness riders should not exceed 100% of the premium under the basic product, and the premiums for all other life insurance riders should not exceed 30% of the premiums under the basic product. Additionally, any benefit arising from these riders should not exceed the sum assured under the basic product.

Frequently asked questions