Tax Implications on Life Insurance

Many investors take insurance as tax saving instruments. The life insurance premium up to maximum of Rs. 1.5 lakh per financial year qualifies for tax deduction under section 80C of the Income Tax Act. Most of the people leave tax planning till the end of the financial year. When the financial year comes to an end, most of the people reach financial product agents to understand the product features so that they can save tax.

According to financial planners, the retail customers should not mix their insurance and investment needs. Most people end up buying insurance products to meet 80C tax deduction limit targets. People then prefer to buy Unit-linked Insurance plans (ULIP) and endowment plans as they offer dual benefits of insurance and investment to a person.

It is however better to keep your insurance and investment needs separate. A lot of people buy insurance products just to save taxes. But many such products may not offer you the expected tax benefits. In this article, we will study more about the tax implications of life insurance policies.

Which Life Insurance Product is Tax deductible?

·       Under section 80C of Income Tax Act, any amount paid towards life insurance premium for yourself, your spouse and children qualifies to be tax deductible.

·         The premium paid by you for your parents, siblings or in-laws is not eligible.

·         Deduction is limited to an overall ceiling of Rs. 1.5 lakhs under section 80C.

How Much Life Insurance is Tax Deductible?

This is the misconception that the entire life insurance premium qualifies for tax deduction. The annual premium up to a maximum of the sum assured is tax deductible, if the policy is issued on or before March 31, 2012. The annual premium up to a maximum of 10 per cent of sum assured is tax deductible, in case the policy is issued on or after April, 1, 2012. If a person is suffering from disability or severe disability (as specified under section 80 U) or to those suffering from a disease or ailment as specified under section 80DDB, an additional relaxation of 5 percent (i.e. up to 15 percent of sum assured) is available. For a life insurance policy, sum assured is the minimum amount assured to the beneficiary of the policy holder in the event of death of the policy holder.

For instance-

If a person purchases an insurance policy with a sum assured of Rs 8 lacs and an annual premium of Rs 1 lakh, only Rs 80,000 (10 % of the sum assured) is tax deductible. He or she will not get any benefits for the balance premium. Under section 80C of the Income Tax Act, any premium in excess of the aforesaid limit (10 % of the sum assured for the new policies) shall not qualify for tax deduction.

Tax Implications of Life Insurance Proceeds-

There is a misconception that the maturity proceeds from life insurance products are also exempted from tax. This is false.

In case of death of the policy holder, the proceeds from the insurance policy are tax free. In other cases than death, the proceeds from the insurance policies do not meet the criteria (percentage of sum assured) and are taxable at the time of maturity. Thus, for any new policy where the annual premium for any year during the tenure of the policy exceeds 10 % of the sum assured, the insurance proceeds other than in case of death are taxable. The insurance proceeds will be taxed to the policy holder at marginal income tax rate (as per income tax slab).

Which Insurance Products to Skip?

Pure life insurance plans are hard to be hit by these conditions. The sum assured in term insurance plans is very high multiple of annual premium. For example- for a 30 year old nonsmoker person, sum assured of Rs 1 crore will cost an annual premium of Rs. 6,000 to 12,000. There are no maturity benefits, but death benefits are exempt from tax.

TDS on Insurance Proceeds-

In the budget 2014-2015, the government introduced a provision for tax deduction at source (TDS) of 2 % if the insurance proceeds are not exempted from tax. Now, it is on the insurance company to deduct TDS of 2 % if the insurance proceeds are not tax exempt. This can call for income tax department to send a tax demand. If the maturity proceeds are less than Rs. 1 lac no TDS will be deducted.