Term Insurance Payouts In India: Understanding The Tax Implications

In India, term insurance is covered under sections 80C, 80D, and 10(10D) of the Income Tax Act of 1961, offering tax benefits to policyholders. The death benefit paid to the nominee or beneficiary upon the insured person's demise is generally tax-exempt under Section 10(10D) of the Act. This exemption ensures that the family or dependents of the insured receive the entire sum without any tax deductions, providing financial relief during a difficult time. Additionally, premiums paid towards term insurance are eligible for tax deductions under Section 80C, with a maximum deduction of ₹1.5 lakh per financial year. It's important to note that tax laws are subject to change, and individuals should consult tax professionals for the most accurate and up-to-date information.

Death benefits are tax-exempt under Section 10(10D) of the Income Tax Act

Section 10(10D) is an essential provision that allows policyholders to receive benefits without incurring additional tax burdens. It covers Unit Linked Insurance Plans (ULIPs) with a total premium of less than 2.5 lakhs in a financial year, and the tax exemption applies to proceeds received at maturity or in the case of premature withdrawal. To be eligible for the exemption, the policy must satisfy certain conditions, such as having been in force for at least two years and meeting specific criteria for the sum assured and premium paid.

The exemption under Section 10(10D) also applies to the returns earned from a Unique Linked Insurance Plan (ULIP). It is important to note that the provisions of this section are subject to change based on amendments to the Income Tax Act. For example, the Union Budget 2023 introduced provisions addressing concerns about high-premium ULIPs, limiting the tax exemption for these plans.

The death benefit paid to the nominee or legal heir of the policyholder is exempt from tax under Section 10(10D). This provision helps protect the financial interests of the family or dependents in the event of the policyholder's death. It is crucial to understand the terms of Section 10(10D) to make informed financial decisions and efficiently manage tax liability.

Premiums paid are eligible for tax deductions under Section 80C

Section 80C of the Income Tax Act, 1961, allows taxpayers to reduce their taxable income by investing in specified instruments such as life insurance, tax-saving fixed deposits, equity-linked savings schemes, and more. The maximum deduction allowed under this section is Rs. 1.5 lakh per financial year. This section is applicable to individuals and Hindu Undivided Families (HUFs) and can be claimed for premiums paid towards life insurance policies for self, spouse, or children.

Conditions for availing tax deductions under Section 80C for life insurance premiums

There are certain conditions that must be met to avail of the tax deductions under Section 80C for life insurance premiums. These include:

• The yearly premiums paid should not exceed 10% of the sum assured. If the premiums exceed 10%, deductions will be applied proportionately.
• For policies issued before 31st March 2012, the deduction will only be applicable if the yearly premium does not exceed 20% of the sum assured.
• As per Section 80C(5), if a policy is voluntarily surrendered or terminated before two years from the beginning of the policy, the policyholder will not receive Section 80C tax benefits on premium payments.

Other investments eligible for tax deductions under Section 80C

In addition to life insurance premiums, there are several other investments that qualify for tax deductions under Section 80C. These include:

• Public Provident Fund (PPF)
• Equity Linked Savings Scheme (ELSS)
• National Pension Scheme (NPS)
• Unit Linked Insurance Plan (ULIP)
• Sukanya Samriddhi Yojana
• Senior Citizen Savings Scheme
• National Savings Certificate
• Tax-saving fixed deposits with a lock-in period of 5 years

Benefits of availing tax deductions under Section 80C

Availing of tax deductions under Section 80C provides taxpayers with an opportunity to reduce their tax liability while also investing in instruments that offer financial returns. By strategically investing in these options, individuals can claim deductions up to the specified limit and lower their taxable income.

It is important to note that the benefits under Section 80C are available only if the taxpayer chooses the "Old Tax Regime." The new tax regime does not allow deductions under this section.

Maturity proceeds are generally tax-exempt under Section 10(10D) of the Income Tax Act

Maturity proceeds from a life insurance policy are generally tax-exempt under Section 10(10D) of the Income Tax Act, 1961. This provision offers significant financial relief to policyholders by exempting specific proceeds received from life insurance policies from taxation or income tax. This means that policyholders or their beneficiaries can receive these benefits without incurring additional tax burdens.

Section 10(10D) covers the taxability of payments received under life insurance policies and Unit Linked Insurance Plans (ULIPs). It is important to note that the tax exemption applies to the sum assured and accrued bonuses received under a life insurance policy claim, subject to certain conditions and exclusions. For example, the benefit amount must be paid upon the death of the policyholder, and the policy must not be a Keyman Insurance Policy. Additionally, the benefit payout should not be an annuity or retirement payout, and it should not be received under a group insurance policy provided by the company.

The eligibility criteria for tax exemptions under Section 10(10D) include having a life insurance policy, including death and maturity benefits, and there is no maximum limit on the coverage amount. Both Indian and international life insurance companies are eligible for tax benefits under this section. It is important to note that Keyman Insurance Policy payouts are not eligible for tax deductions.

The requirements for maturity returns under Section 10(10D) vary depending on the date of policy issuance. For policies issued before April 1, 2012, there is no limit on the premium paid compared to the sum assured, and the entire maturity benefit received is tax-free. However, for policies issued after this date, the premium paid cannot exceed 10% of the sum assured for the maturity benefit to be exempt from tax. If the premium exceeds this limit, the portion exceeding 10% of the sum assured will be taxable as income.

It is worth mentioning that Section 10(10D) also covers additional exemptions for specific types of policies, such as policies for persons with disabilities (Section 80U) and critical illness cover riders. In these cases, maturity benefits received are exempted from tax, regardless of the premium paid.

While Section 10(10D) offers tax exemptions on maturity proceeds, it is important to be aware of situations where the beneficiary may still have to pay taxes. One such scenario is when the policyholder chooses not to have the benefit paid out immediately. In this case, the insurance company holds the amount until payout, and the accumulated interest portion is typically liable for taxes.

Surrender value may have tax implications under the Income Tax Act

In India, the surrender value of a term insurance policy is allowed as a tax-free benefit only if it fulfils certain conditions. These conditions relate to the type of plan, the date of issue, and the sum assured in relation to the premium paid.

For traditional plans such as endowment or money-back policies, the surrender value is tax-free if the premiums for the first two years have been fully paid. For single premium traditional plans, the surrender value is tax-free if the plan has been held for at least two years. Unit-linked insurance plans (ULIPs) must be held for at least five years for the surrender value to be tax-free.

The date of policy issue also determines the taxability of surrender value. Policies issued before March 31, 2003, are completely tax-free. For policies issued between April 1, 2003, and March 31, 2012, the surrender value is tax-free if the sum assured is at least five times the annual premium. For policies issued on or after April 1, 2012, the sum assured must be at least ten times the annual premium amount for tax exemption.

There are additional considerations for policies issued on or after April 1, 2013, covering individuals with disabilities or specific ailments. In these cases, the surrender value is tax-free if the sum assured is at least 6.67 times the annual premium.

If the surrender value does not meet the above criteria, there may be dual tax implications. Firstly, any premium exemption claimed under Section 80C of the Income Tax Act will be reversed, resulting in additional tax on exemptions previously claimed. Secondly, the surrender value will not be exempted under Section 10 (10D) and will be treated as 'income from other sources', taxed according to the existing tax bracket.

It is important to note that the above information is subject to change and may not cover all possible scenarios. Individuals are advised to consult a tax professional or financial advisor for accurate and up-to-date information regarding the tax implications of surrendering a life insurance policy in India.

Riders attached to a policy may have separate tax implications

Riders are additional provisions or modifications to an insurance policy that provide extra coverage or protection against risk. They are optional and available at an extra cost. Riders can be added to policies that cover life, homes, autos, and rental units. They are useful for tailoring an insurance policy to the precise needs of the insured entity.

When it comes to tax implications, it is important to note that riders are subject to tax rules. In India, the tax structure is divided into direct and indirect taxes. Direct taxes are levied on taxable income earned by individuals and entities, while indirect taxes are levied on the sale and provision of goods and services. The tax incidence of an individual depends on their residential status as defined by the Income Tax Act.

The specific tax implications of adding a rider to an insurance policy may vary depending on the type of rider, the jurisdiction, and the prevailing tax laws in India. It is always advisable to consult with a tax professional or financial advisor to understand the tax consequences of adding a rider to an insurance policy.

• Premium Waiver Rider: This rider waives future premium payments if the policyholder becomes disabled, injured, or dies during the policy term. The tax implications of this rider may depend on how the waived premiums are treated for tax purposes.
• Accidental Death Benefit Rider: This rider provides an additional benefit in the event of the insured's accidental death. The tax treatment of this rider may depend on whether the additional benefit is considered taxable income.
• Critical Illness Rider: This rider provides a benefit if the insured is diagnosed with a critical illness listed in the policy. The tax implications may depend on whether the benefit is considered taxable income and how it interacts with any existing health insurance coverage.
• Long-term Care Rider: This rider provides coverage for long-term care needs and may impact taxes depending on how the benefits are utilized and any existing healthcare policies.
• Term Conversion Rider: This rider allows the conversion of term life insurance to permanent life insurance without a medical exam. The tax implications may depend on the tax treatment of the new permanent life insurance policy.
• Waiver of Premium Riders: This rider waives premium payments if the policyholder becomes critically ill, disabled, or injured. The tax implications may depend on whether the waived premiums are considered taxable income.
• Exclusionary Riders: These riders restrict coverage for specific events or conditions and may have tax implications depending on the specific exclusions and their impact on the taxable value of the policy.

Frequently asked questions