How Life Insurance Policies are Taxed: Key Insights and Tax Benefits Explained”

In India, insurance policyholders can save taxes by investing in life insurance policies under the Income Tax Act of 1961. The policyholders can save their taxes and maintain financial security for themselves and their family members. These tax benefits are bifurcated into two parts, namely, deductions and exemptions, which have their own applications. 

Tax Deductions:

The Income Tax Act of 1961 allows policyholders to save their taxes by investing in their gross total income.  The life insurance premiums paid are eligible for the tax deductions u/s 80C. To avail of this benefit, a policyholder is required to invest a maximum of INR 1,50,000 per annum as per the Income Tax Act, 1961. These benefits include the premium paid for the Life Cover bought for the spouse or children. 

Tax Exemptions:

This part of income is not subject to tax and is excluded from the total income. Tax exemptions are applicable on the insurance policy proceeds, falling u/s 10(10D) of the Income Tax Act, 1961.

How to Save Income Tax with Life Insurance Policy?

The income tax can be saved by buying a life insurance policy at different stages of the insurance plan, as discussed below:

Stage 1: Entry Advantage

This stage is about the eligibility for tax deductions u/s 80C, 80CCC, and 80D of the Income Tax Act. 

80C – Life Insurance

80CCC- Pension Plans

80D- Health Insurance

Stage 2: Earnings Advantage

Investment done in the life insurance policy will continue to grow over a period of time and is exempt from tax (subject to certain terms and conditions).

Stage 3:  Exclusive Switching Advantage

This stage is about switching between different investment options available, such as debt, equity, or other funds which are not taxable.

Stage 4: Exit Advantage

The proceeds from the policy are eligible for exemption from tax u/s 10(10D) of the Income Tax Act, 1961, subject to certain terms and conditions.

Life Insurance Benefits under Different Sections of the Income Tax Act, 1961

Mentioned are the different sections of the Income Tax Act, 1961:

• Section 80 C 

This section helps reduce the policyholder’s tax liability by paying the premium towards the life insurance policy. One can avail of a tax deduction of up to INR 1.5 lakhs per annum.

• Section 80 D

This section allows one to get a tax deduction by making payments towards health insurance premiums against the policy taken for self, spouses, children, and parents. The maximum tax benefit can be up to INR 25,000 per annum and INR 1,00,000 in case the insured or his parents are above 60 years of age. Along with such benefits, one can also avail oneself of INR 5000 worth of preventive healthcare benefits.

• Section 10(10D)

This section provides tax exemption on the proceeds of the policies received upon maturity, including life insurance policies and death or maturity benefits.

• Section 80CCC

This section allows tax deductions when making payments of the premium of pension or retirement plans, a maximum of up to INR 1.5 lakhs a year. In case the policyholder surrenders the policy, the amount received thereon shall be taxable as income in case the deductions are claimed under section 80CCC.

• Sec 10(10A)

This section allows commuted pensions or proceeds from pension funds to be exempt from tax for government employees. 

• Section 80CCE

This section puts a restriction on the maximum deduction amount u/s 80C, 80CCC, and 80CCD to INR 1.5 lakhs per annum.

Taxation Rules

In normal circumstances, the life insurance proceeds are tax-free, subject to the terms and conditions of the Income Tax Act of 1961. Here are some exceptions to the same:

• In case of a policy issued between 1^st April 2003 and 31st March 2012, the annual premium should not be above 20% of the sum assured.
• If the policy is issued on or after 1^st April 2012, the premium amount should not be above 10% of the sum assured.
• In case any person is suffering from any disability or disease as mentioned under Section 80U and 80DDB, respectively, the premium should not exceed 15% of the sum assured.

In case of a premium exceeding the above-mentioned percentages, i.e. 10%, 15%, or 20% of the sum assured, the policy proceeds would be taxable. Also, one can use an Income Tax Calculator to calculate the taxes on proceeds from the policy.

Eligibility Criteria

The tax deductions and exemptions can be availed by:

• Indian Individual or Hindu Undivided Family
• Any Indian resident whose income comes under the taxation slab.
• As per Section 80C of the Income Tax Act, 1960, any senior citizen whose income comes under the taxation slab.
• Any Indian resident having a policy registered under his/ her name or the name of his/her spouse or children.

TDS on Life Insurance Policy

Since October 2014, it has been declared that proceeds from life insurance above INR 1 lakhs are not exempt from tax under section 10(10D), and the insurance company is bound to deduct the 1% TDS while making payments. Where the income does not exceed INR 1 lakhs, the TDC will not be deducted, but the income will remain to be taxable.

Any proceeds of the life insurance policy paid on or after 1^st October 2019, TDS shall be deducted @5% of the net proceeds as per Union Budget, 2019. Below mentioned are some exemptions to TDS u/s 194DA:

• Any amount received u/s 80DD(3) or 80DDA(3).
• If the policy was purchased between 1st April 2003 and 31st March 2012, and the premium amount paid to the insurance company doesn’t exceed 10% of the sum assured.
• No TDS if the life insurance policy falls under the purview of Sec10 (10D).

GST on Life Insurance Policy

Before GST, policyholders were required to pay a service tax of 15%, which included Service tax, Swachh Bharat Cess, and Krishi Kalyan Cess. After the successful implementation of GST, a flat GST of 18% on the insurance premium. 

Conclusion

One should not buy an insurance policy just due to an intention of availing tax benefits. The policyholder should have clarity with the goals, personal aspects, income, affordability, etc. Having a clear understanding of how life insurance policies are taxed is important for someone who wishes to invest. Also, the income tax calculator is an important tool that helps determine the tax implications of the life insurance policy and helps plan the financial future accordingly. It ensures the maximisation of savings and the minimisation of tax liabilities.