In addition to the death and maturity benefits, life insurance plans can also provide tax breaks under Section 80C and Section 10(10D) of the Income Tax Act of 1961.In addition to a payout at maturity or passing away, life insurance contracts may also provide tax breaks under Sections 80C and 10(10D) of the Income Tax Act of 1961.
A life insurance policy is, at its core, a legal agreement between you and an insurer.
Leaving loved ones unprotected financially is a terrifying prospect. With life insurance, your loved ones won’t have to worry as much about making ends meet if something were to happen to you.
A life insurance policy is essentially a contract between you and an insurance provider. Periodic premium payments made by you, the policyholder, to the insurance company are repaid in full either upon the death of the insured (the “death benefit”) or upon the expiration of the insurance term (maturity benefit).
Tax Advantages of Having a Life Insurance Policy.
The Income Tax Act of 1961 provides tax breaks for those who purchase life insurance policies through Section 80C and Section 10(10D).So, it’s important to grasp the two provisions that impact taxes on life insurance –
Paragraph 80 C
To the tune of 1.50 lakh per year, life insurance premiums paid by any taxpayer (resident or non-resident) are tax deductible under Section 80 C. You can deduct this amount in addition to any other qualifying expenses, such as your PPF, NSC, ELSS, fixed deposits, home loan payments, tuition, fees, provident fund contributions, etc.
Your premiums for a life insurance policy are tax deductible under Section 80C only to the extent that they exceed 10% of the sum assured. However, the deduction cannot be taken into account for premiums in excess of 10%. Up to 15% of the money insured is exempt, up to a maximum of INR 1.5 lakh per year, for those who qualify as handicapped persons or who are critically ill.
The Tenth Paragraph (10D)
The tax-free status of the death benefit from your life insurance policy is determined by whether or not the policy’s maturity profits qualify under Section 10 (10D) of the Income-tax Act. All insurance payouts, such as death benefits, plan maturities, and bonus payments, are subject to Section 10(10D).
Remember that death benefits are never subject to taxes. Taxes may be levied on maturity benefits (payments made after a predetermined length of time has passed) depending on the amount of the premium.
Any maturity funds (survivor benefits) from a life insurance policy purchased on or after April 1, 2012, and for which the yearly premium exceeds 10% of the sum insured, will be subject to taxation at the individual’s marginal income tax rate. If not, the money can be kept without paying taxes.
If you purchased a life insurance policy between April 1, 2003 and March 31, 2012, and you want to avoid paying taxes on the premium, the insured sum must be less than 20% of the premium.
In case you forgot, ULIPs are insurance policies that double as investments and provide life insurance coverage if you pay the premium for a set number of years (often about 5). (usually for a sum insured of 10 lakhs). The maturity benefit is paid out after a holding period, typically 5 years after the premium payment term has ended.
Therefore, a common ULIP would have you pay 1 lakh each year for 5 years, and then have the insurer return to you 10 lakhs* in a single payment after another 5 years had passed. In the event of your untimely demise during this period, your heirs will be compensated with an additional INR 10 lakhs.
As ULIPs are tied to the equities and debt markets, returns can and do fluctuate, this is merely an example.Historically, both the premiums paid for a ULIP and the benefits received upon its maturity were exempt from taxation under Section 80C and Section 10, respectively (10D).
However, a new rule regarding ULIPs became effective as of February 1, 2021, and applies to ULIP purchases made on or after that date. The regulation is basic:There is no tax exemption on returns from a ULIP if the annual premium paid is more than INR 2.5 lakhs. Any profits are classified as capital gains for tax purposes (not income tax).
Let’s examine some cases: Case 1
Let’s pretend you decide to invest in a ULIP on April 2, 2021. The premium is INR 65,000 per quarter. There will be a maturity benefit payment of INR 21 lakhs on April 2, 2031, after you have paid for the policy for a total of 5 years (initially) and then an additional 5 years (while the insurer invests the money). The life sum insured under the policy was 15 million Indian Rupees (in case you pass away in those 10 years, your family will get 15 lakhs).
According to the 80C limit, you can deduct Rs. 1.5 lakh ($29,000) from your taxable income every year that you make premium payments. You won’t be able to reduce your annual premium of $65,000 times 4 years = $2.6 million from your eventual maturity amount of $21 million. If your annual premium is more than Rs. 2,50,000, you will not be eligible for a tax break and your profits would be treated as long-term capital gains (LTCG).
In the event of your untimely death within the policy’s active period of 10 years, your beneficiaries will receive the whole 15 lakh sum insured, without having to worry about paying any taxes on the money. While the maturity benefit of 21 lakhs will be tax-free after 10 years, the annual premium of more than 2.5 lakhs would still be taxed as long-term capital gains.
Let’s say, for the sake of argument, that on April 2, 2021, you invested in a ULIP. A maturity benefit of INR 12 lakh will be paid by the insurer on 2nd April 2031 if you make the annual payment of 1 lakh for a total of 10 years. If you pass away during the policy’s active period of 10 years, your loved ones will be compensated with INR 5 lakh in life insurance.
You can only deduct INR 50,000 from your taxable income under section 80, even though you pay a premium of 1 lakh. This is due to the fact that a maximum of 10% of the INR 5 lakh life sum assured (also known as the sum insured) can be deducted as a tax credit throughout the course of the five years that the premium is paid.
However, if your annual premium is less than 2.5 lakhs, your maturity benefits would be completely tax-free.
Maintaining a wall between your insurance and investment accounts still produces better results than the alternative. Term life insurance that is supplemented by a solid investment portfolio can provide substantial financial protection for your family at a lower cost than buying a single life insurance policy would. Investment-linked insurance may make sense if you appreciate the ease and security of having the money managed by advisors and are within the applicable tax exemption limitations.
Assurekit’s Chief Operating Officer Avinash Ramachandran and Chief Innovation & Strategy Officer Sunil Padasala wrote this.