Here are Certain Things You Should Know About the Taxability of Life Insurance Payouts
Life insurance products are a great way to protect your family from any eventualities. However, apart from serving as a protective shield for you and your family, life insurance is also a beneficial tax* saving instrument. Even a term insurance policy offering a pure risk cover comes with tax* benefits which is the reason why most policyholders choose term insurance for tax* savings.
In addition to not knowing the many benefits of life insurance policies, many people are also not aware of the tax* benefits of investing in a life insurance plan. On the other hand, some people choose life insurance policies specifically as tax* saving options. But it is always better to benefit from the tax* savings while also fully understanding and enjoying the life cover and other benefits offered by a life insurance plan.
What are the Tax* Benefits of Life Insurance?
Life insurance policies are among the tax* free instruments in India which are mentioned under Section 80C of the Income Tax Act, 1961, thereby allowing policyholders to claim a deduction on premium payments. Furthermore, Section 10(10D) of the aforementioned legislation provides tax* exemption on the death / maturity benefit received from a life insurance policy.
Let's look at how Section 10(10D) of the Income Tax Act, 1961 works.
What is Section 10(10D) of the Income Tax Act?
Under Section 10(10D) of the Income Tax Act, 1961, the sum assured of the life insurance plan along with any applicable bonuses2 from the policy that are paid out on the death of the policyholder or on the maturity of the policy are eligible for tax* exemption. This benefit is also applicable in the case of Unit Linked Insurance Plans (ULIPs), which are market-linked insurance-cum-investment plans.
But when you buy a term life insurance policy for your family that offers only a pure risk cover, only the death benefits are eligible for tax* benefits under this section since there are no maturity benefits in term plans unless with the addition of a return of premium rider#.
In the case of Section 10(10D), there are two scenarios to consider for tax* exemption:
Death benefits: Under a life insurance plan, if the policyholder passes away during the tenure of the policy, the sum assured, as determined at the commencement of the policy, is paid out to the beneficiaries the individual. This death benefit is tax*-exempt under Section 10(10D).
Maturity benefits: Under a life insurance policy, if the policyholder outlives or survives the policy term, they receive the maturity proceeds including any applicable bonuses2. These maturity proceeds qualify for a tax* exemption under Section 10(10D).
How does Section 10(10D) Apply to Life Insurance Payouts?
As per Section 10(10D) of the Income Tax Act, 1961, the sum assured is paid out to you or your beneficiary as one of the following benefits.
a death benefit
a maturity benefit
a surrender benefit
While the sum assured of a life insurance policy is exempt from tax* under Section 10(10D), there are some terms and conditions that need to be taken into consideration. These terms, however, do not apply to the death benefits that are paid out in the event of your, the policyholder’s, unfortunate demise. This is beneficial when you have to choose from various life insurance plans for your family.
If the premium payment for any life insurance policy exceeds 20% of the sum assured for a policy purchased after April 01, 2003, but on or before March 31, 2012, then the proceeds of the policy will be taxable in the hands of the policyholder.
However, it is important that the sum assured should not include any bonus2 amount or any premium that needs to be paid back to the policyholder. Hence when you opt for a term insurance plan with a return of premium+ option, the payouts will be rendered taxable.
While you can enjoy the benefits of the lump sum payouts, regular income, return of premium on term plans or assured returns of our Tata AIA life insurance plans, this exception is something you should bear in mind.
If you purchase a life insurance policy on or after April 01, 2012, the same conditions as stated above will apply but only if the premium payments exceed 10% of the sum assured under the policy.
As a policyholder, if you are ailing from a disability as specified under Section 80U or suffer from a critical illness as specified under Section 80DDB of the Income Tax Act, 1961, the limit of the premium payments as mentioned above will be increased to 15%.
However, this is applicable for policies that are issued after April 01, 2013. More importantly, you can avail of this benefit only if the said disability or critical illness comes under the particular sections of the Income Tax Act, 1961.
Keeping in consideration the year in which the policy was purchased if the premium amount goes above the 10%, 15%, or 20% limit of the sum assured, the benefits will be taxable for you. However, as has been mentioned above, it is only the death benefits that will not be taxed even if the premium amount exceeds the stipulated limits.
What Else Should You Know About the Taxability of Your Life Insurance Payouts?
There are two more key points to remember when it comes to the tax* rules under Section 10(10D):
Firstly, if any payout from a life insurance policy is not eligible for tax* deductions under the Keyman Insurance Policy, then the benefits of Section 10(10D) will be applicable for said payouts. It is important to note that a Keyman Insurance Policy is a policy wherein an employer is the proposer of the insurance policy and also pays the premiums for their employees; however, the life insured is the employee of the former and the benefits (in the event of a claim), will be paid out to the employer.
Secondly, if the maturity benefits of your policy do not qualify for a tax* exemption under Section 10(10D), then a 5% TDS (Tax Deducted at Source) will be calculated on incremental amount i.e. after reducing the premium paid from the total amount payable on maturity provided PAN details are updated. However, if you do not submit the PAN details, a TDS of 20% will be applicable on the maturity benefits. The TDS rate for NRI policy holder is governed by section 195 at 30% plus applicable surcharge and cess.
As a taxpayer, you should not aim to use a life insurance policy primarily as a tax-saving tool; however, it is important to understand how you can use the policy to provide protection to your family while enjoying its tax-saving benefits.