Taxability of Life Insurance Policy Payouts

A life insurance policy has several benefits. It gives financial security against premature death, helps you plan for your and your family’s financial goals, helps create a secured corpus, and gives tax benefits. Yes, the tax angle of a life insurance plan appeals too many. In fact, life insurance plans are considered to give you triple tax benefits under the EEE (Exempt, exempt, exempt) concept. Here’s how –

• The premium that you pay is allowed as a deduction
• The returns earned from the policy are tax-free
• The policy pay-outs are also tax-free

All of the above are subject to provisions stated in the Income Tax Act, 1961 Now, let’s see the tax benefits that you get on the premium and also on the life insurance payout –

Taxability of life insurance premiums

The life insurance premiums that you pay for a life insurance policy are allowed as a deduction u/s 80C of the Income Tax Act, 1961.

The limit of deduction is up to Rs.1.5 lakhs, and your premium should be up to 10% of the death sum assured, if policy is issued after 31 March 2012. However, if the premium happens to exceed 10% of the death sum assured, you would be allowed a deduction only on premiums equal to 10%. The remaining premium would not be eligible for deduction under Section 80C of Income Tax Act. For policies issued on or prior to 31 March 2012, such limit is 20% of death sum assured. Let’s simplify this with an example.

Say you buy a life insurance plan with a sum assured of Rs.10 lakhs. The premium is Rs.75,000.

You can claim a deduction of the full Rs.75,000 since the premium is within 10% of the sum assured. Moreover, since Section 80C allows a deduction up to Rs1.5 lakhs, the entire premium amount can be availed as a deduction.

If the premium paid would have been Rs.1.5 lakhs, you would not have gotten the full deduction. 10% of the sum assured is Rs.1 lakh. The deduction, thus, would be limited to Rs.1 lakh. An interesting thing to note is though Section 80C allows deductions up to Rs.1.5 lakh, you qualify only for a deduction of Rs.1 lakh since the premium is more than 10% of the sum assured.

Taxability of life insurance pay-outs

When it comes to pay-outs, there are three main types of life insurance pay-outs that you might receive –

• Surrender benefit
• Death benefit
• Maturity benefit

Let’s understand the taxability of each –

1. Surrender benefit

If you surrender your life insurance policy after two years, the surrender benefit that you receive would be tax-free under Section 10(10D) subject to satisfaction of conditions mentioned therein. In the case of ULIPs, there is a lock-in period of five years. The surrender benefit that you receive after five years would be tax-free in your hands subject to satisfaction of conditions mentioned under Section 10(10D) of Income Tax Act.

Remember, if you surrender the policy before two or five years, the tax benefit that you received on the premium would be reversed. You would have to pay taxes on the premiums claimed as deduction in the year that you surrender the plan.

2. Death benefit

The death benefit of a life insurance policy is always tax-free in the hands of the nominee or the beneficiary. There are no conditions attached to the tax exemption on the death benefit. The pay-out always qualifies for an exemption irrespective of the amount that the policy pays.

3. Maturity benefit

The maturity benefit that you receive from a life insurance policy qualifies for a tax exemption under Section 10(10D) of the Income Tax Act, 1961. The entire benefit amount, including bonus if any, guaranteed additions, loyalty additions, etc., would be eligible for exemption. However, the exemption would be available only if your annual premium was up to 10% of the death sum assured. If the premium exceeded 10% of the sum assured, the gain/income from policy at the time of maturity will become taxable. Gain/income from policy is the difference between maturity proceeds received and total premium paid under policy.

So, in the above examples, when the premium was Rs.75,000, you can claim a full deduction under Section 80C, and the maturity benefit would also be fully tax-free. However, in the latter case, when the premium was Rs.1.5 lakhs, you get a partial deduction under Section 80C, and the gain at the time of maturity would also be taxed in your hands at your existing slab rates.

Taxability of life insurance pension plans

Pension plans have different taxability compared to other types of life insurance plans. Here’s how –

• The total premium paid would be considered as a deduction under Section 80CCC. The limit is Rs.1.5 lakhs which includes the limit allowed under Section 80C.
• On maturity, if you commute a part of your corpus, 1/3rd of the commuted corpus would be allowed as a tax-free income under Section 10(10A).
• Annuity or pension payments are taxed at your income tax slab rates.

TDS on life insurance pay-outs

TDS applies to the maturity benefit if both the following conditions are fulfilled –

• The premium is more than 10% of the death sum assured, and the benefit is not exempted under Section 10(10D)
• The maturity benefit is more than Rs.1 lakh.

The TDS rate is 5% if you have submitted your PAN Card. If you haven’t, the rate is 20%.

Note that if maturity benefit is less than Rs. 1 lakhs, Company will not deduct TDS on gain from policy, however, Customer should pay applicable income tax in his Income Tax Return in the year of maturity.

The bottom line

While life insurance plans have a tax benefit, understand this benefit when planning your taxes. Check the taxability of your premium and policy payouts to file your returns correctly.

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