Term Life Insurance: Tax Implications And You

Term life insurance offers financial protection for your loved ones in the event of your death. It's a type of pure protection policy, meaning it only offers a payout if the policyholder dies. This payout is typically tax-free and can provide financial stability for your family.

In addition to this death benefit, term life insurance policies can offer tax benefits to the policyholder. These benefits are covered under the Income Tax Act, 1961, in India, and include deductions and exemptions.

Under Section 80C, you can claim deductions of up to ₹1,50,000 per year on premiums paid towards your term insurance policy. The premium amount must be less than 10% of the sum assured to qualify for these deductions.

Section 80D, which primarily deals with health insurance, can also provide benefits for term life insurance policyholders who have added health-related riders, such as critical illness cover. This allows for additional deductions of up to ₹25,000 for self, spouse, and dependent children, and an additional ₹50,000 for senior citizens.

Furthermore, under Section 10(10D), the death benefit received by your nominee is completely tax-free, ensuring your loved ones receive the full amount.

While term life insurance offers tax benefits, it's important to consider other factors when purchasing a policy, such as adequate sum assured, affordability, and fulfilment of specific needs.

Tax benefits under Section 80C of the Income Tax Act

Term insurance is a pure protection plan that offers coverage against an unfortunate event during the policy term. One of the most significant advantages of a term plan is the tax benefits associated with it. Here are the tax benefits under Section 80C of the Income Tax Act, 1961:

• Section 80C allows deductions of up to ₹1.5 lakh per annum on premiums paid towards term insurance plans. This includes other listed investments such as PPF, EPF, ULIP, ELSS, and payments like repayment of home loans, children's tuition fees, and life insurance premiums.
• To avail of the tax benefits under Section 80C, the yearly premiums paid should not exceed 10% of the sum assured. If it does, the deduction is applied proportionately.
• For policies issued before March 31, 2012, the deduction is applicable only if the yearly premium does not exceed 20% of the sum assured.
• As per Section 80C(5), if the policy is voluntarily surrendered or terminated within two years from the inception, the policyholder will not receive tax benefits on premium payments.
• The premium paid towards term insurance plans can be claimed as a deduction from the taxable income, reducing the tax liability.
• The deductions under Section 80C are available only under the old tax regime.

Tax benefits under Section 80D of the Income Tax Act

Section 80D of the Income Tax Act, 1961 offers tax deductions on health insurance premiums paid for self, spouse, dependent children and parents. It also includes tax deductions on contributions made to any government health insurance scheme and the cost of preventive health check-ups.

• Individuals and Hindu Undivided Families (HUFs) are eligible for tax deductions under Section 80D. NRIs paying tax in India can also claim tax deductions if they have paid health insurance premiums to an insurance company in India.
• The tax deduction limit is ₹25,000 per financial year for non-senior citizens and ₹50,000 for senior citizens aged 60 years and above.
• This limit includes a ₹5,000 deduction for expenses paid towards preventive health check-ups.
• Health insurance premiums paid in cash are not eligible for Section 80D deductions.
• If an individual and their parent have paid medical insurance premiums in part, then both can claim tax deductions for their paid amount under Section 80D.
• Premiums paid for siblings, grandparents, uncles and aunts are not qualified for tax deductions.
• Premiums paid on behalf of working children are not eligible for Section 80D deductions.
• Group health insurance premiums paid by the employer are not eligible for deductions.
• No deduction is provided on the service tax and cess amount added to health insurance premiums.
• Tax deductions under Section 80D are over and above those claimed under Section 80C.

Tax benefits under Section 10(10D) of the Income Tax Act

Section 10(10D) of the Income Tax Act offers tax benefits for term life insurance policyholders. This section allows tax exemptions on the sum assured and accrued premium when filing income tax returns. It covers all types of life insurance claims, including death benefits, maturity benefits, and bonuses. Here are the key advantages and provisions under Section 10(10D):

• Tax Exemption on Death Benefits: The death benefit paid to the nominee or legal heir of the policyholder is fully exempt from tax under Section 10(10D). This provides financial security to dependents without tax burdens.
• Tax Exemption on Maturity Benefits: The maturity benefit received by the policyholder at the end of the policy term is also exempt from tax under Section 10(10D).
• Eligibility Criteria: To be eligible for tax benefits under Section 10(10D), the policy must be a life insurance policy, providing coverage in the event of the policyholder's death. The policy must also be in force for a minimum of two years, and it should be issued on or after April 1, 2012.
• Tax Deduction on Premiums: Premiums paid for term insurance qualify for tax deductions under Section 80C of the Income Tax Act, with a maximum deduction of ₹1.5 lakhs per annum.
• No Upper Limit on Exemption: There is no upper limit on the tax exemption for the death benefit under Section 10(10D).
• Eligibility Based on Premium Payments: The eligibility criteria for tax exemption vary depending on when the policy was purchased. For policies purchased between April 1, 2003, and March 31, 2012, the annual premium must not exceed 20% of the sum assured. For policies purchased after April 1, 2012, the premium paid in any financial year should not exceed 10% of the sum assured.
• Special Exemption for Severely Disabled or Ill Individuals: For policies obtained before April 1, 2013, where the insured person has a severe disability or critical illness, the premium can be up to 15% of the sum assured, as specified in Sections 80U and 80DDB, without losing eligibility for the tax exemption.
• Exclusions: Section 10(10D) does not provide tax exemptions for payouts received under Keyman Insurance Policies or payouts received under Sections 80DD (3) or 80DDA (3) of the Income Tax Act.
• TDS on Life Insurance Policies: Any payment from a life insurance plan exceeding ₹1 Lakh is subject to 1% TDS if the policy is not applicable under Section 10(10D). This provision has been effective since October 2014.
• Tax Exemption for ULIP Plans: The Finance Bill 2021 proposed amendments to Section 10(10D), stating that the provision should not apply to ULIPs purchased on or after February 1, 2021, with an aggregate annual premium of more than ₹2,50,000. ULIP plans will be treated as capital assets, and maturity, surrender, or partial withdrawal proceeds will be taxed as Capital Gains. However, in the event of the policyholder's death, the entire death benefit remains tax-exempt.

Tax benefits on term insurance riders

Term insurance riders are amendments or attachments to a term insurance plan, providing additional coverage and enhancing the policy's utility. Riders offer several benefits, including:

• Accidental Death Rider: Pays an additional sum assured to the beneficiary if the insured passes away due to an accident. The additional sum is calculated based on the original sum assured and may vary between companies.
• Critical Illness Rider: Protects policyholders against major illnesses like cancer, heart attack, kidney failure, and paralysis. It provides a lump sum amount upon diagnosis of a pre-specified medical condition.
• Accelerated Death Benefit Rider: Allows the policyholder's family to receive a portion of the sum assured in advance if the policyholder is diagnosed with a terminal illness. This amount can help cover medical expenses.
• Accidental Disability Benefit Rider: Covers the risk of the insured becoming partially or permanently disabled due to an accident. The rider provides an income source by paying a percentage of the sum assured for a specified period after the accident.
• Waiver of Premium Rider: Waives future premiums if the policyholder becomes unable to pay due to disability or income loss, keeping the policy active.
• Income Benefit Rider: Provides an additional income source for the policyholder's family after their death. The family receives an annual income for a specified period, in addition to the sum assured in the term plan.
• Child Support Benefit Rider: Pays an additional sum assured upon the death of the parents (policyholders) to ensure the child's needs are met and financial goals are achieved.

The premium paid for riders that are part of a term insurance plan are deductible up to specific limits under Section 80D of the Income Tax Act, 1961. The limits depend on the age of the insured, with higher limits for senior citizens.

Riders offer greater coverage and protection for families at affordable prices. They are a cost-effective way to enhance a term insurance plan without the need for multiple policies.

Tax implications of not paying premiums

Life insurance premiums are generally not tax-deductible. However, there are certain circumstances where not paying premiums can have tax implications.

Firstly, if you have a term insurance plan, failing to pay premiums regularly can result in the loss of tax benefits. For example, in India, under Section 80C of the Income Tax Act, policyholders can claim deductions of up to a certain limit per year for the premiums they pay. However, if the policyholder fails to pay the premiums on time and the policy lapses, they may lose their eligibility for this tax deduction.

Secondly, in the context of employer-provided life insurance, if your employer pays the premiums for your life insurance as part of your compensation package, it is generally considered taxable income. If your employer pays for more than a certain amount of life insurance coverage (for example, $50,000 in the US), the premium cost for the excess coverage is typically added to your taxable income. Therefore, if you fail to pay the premiums yourself and your employer does not cover them, the tax implications may include an increase in your taxable income.

Additionally, in the case of whole life insurance policies, the policy's cash value accumulates over time, and this growth is considered taxable income. However, you are not required to pay taxes on this growth annually. Instead, the accumulation of cash value is tax-deferred, and you will only need to pay taxes when you cash out the policy. Therefore, if you stop paying premiums, the cash value will no longer grow, and you may have a smaller amount of taxable income when you eventually cash out the policy.

Furthermore, if you have taken out a loan against the cash value of your whole life insurance policy, failing to pay premiums can affect the death benefit. The loan amount, including any interest owed, will reduce the death benefit until the loan is repaid. Therefore, if you do not pay the premiums and the loan amount exceeds the cash value, your beneficiaries may receive a reduced payout upon your death.

Lastly, in certain business contexts, if a business owns or pays for a life insurance policy on an employee's life, and the employee leaves the company or the policy is transferred to the employee, the fair market value of the policy may be treated as taxable compensation to the employee. Therefore, if the business fails to pay the premiums and the policy lapses, it may result in taxable income for the employee.

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