The general public has a common notion that the premium paid towards life insurance policies is entirely free of tax. It may be true under certain circumstances, but not for all kinds of premiums. It is crucial for an investor to have some knowledge about when these premiums are tax-free and when they are not.When the policyholder is aware of the tax implications, he can take advantage of the tax benefits. When you understand all the intricacies of tax benefits, you will not lose money to taxes. Here we will explain how the taxation aspect of life insurance works.
Insurance & Investment are Two different entities
As per Section 80(C) of the Income Tax Act, passed by the Government of India in the year 1961, the premium paid towards the life insurance policies amounting up to Rs 1.5 lakh is eligible for tax exemptions. However, the decision to invest in a policy should not be solely based on tax exemptions.
A policyholder should never incorporate his insurance needs with that of his investment requirements. An insurance product can act as a tax saving instrument, but not only as that. A common error people make while purchasing insurance products such as endowment and ULIP plans is only to save tax.
An investment plus insurance plan maybe be beneficial for a few, but for a good tax benefit option, it is safe not to combine the two.
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Tax Deductible Life Insurance Premiums
The section 80C of The Indian Income Tax Act permits tax benefits for insurance premiums up to Rs 1.5 lakh.
Section 80(C) Explained
Section 80C(2) of the Indian I-T Act, 1961 states that an amount paid by the policyholder to the insurer to buy a life insurance policy or to maintain it is eligible for tax claim. Therefore, an amount equalling to the premium paid for the insurance policies in the name of the applicant can be deducted from the total income (gross amount) while calculating the taxable income.
The Clauses governing the rule are:
• Tax benefits can be availed only by an individual or an HUF (Hindu Undivided Family)
• Tax exemptions are available for policies bought from any IRDA recognised insurance company
• This benefit can be claimed by the policyholder only if the insured person is self, spouse or kids
• The premiums paid towards policy in the names of parents or in-laws or siblings are not eligible for tax benefits
• The sum assured is also free of charge when in the hands of the policyholder
• The premiums should be paid in the same financial year for which tax exemptions are requested
• One or more investment options can be claimed for tax deductions on the condition that the amount does not exceed Rs 1,50,000.
• There are many investment options that are mentioned under this section that includes types of insurance other than life insurance.
• If a policyholder has other kinds of investment under Section 80CCC and Section 80CCD, they will be considered under Section 80C, and the overall limit sums up to Rs 1.5 lakh.
• The premium has to be paid by a cheque or an online account transfer to avail the tax benefits under section 80C.
Section 10 (D) of the Indian I-T Act
The Section 10 (D) states that the sum assured amount plus the bonus paid on maturity of the policy is free of tax. This is also applicable when the policy is surrendered on the death of the insured.The sum assured and the bonus is taxable in the hands of the insured under the following circumstances:
• If a life insurance policy is dated after 1st April 2003 and on or before 31st March 2012 and in case the premium paid in a financial year is more than 20% of the total amount insured, the policy is taxable in the hands of the policyholder or the insured.
• For all life insurance policies that are issued after 1st April 2013, the 20% limit is reduced to 10%.
• In case the premium paid in a financial year exceeds the limits of 10% or 20%, then the whole income from the policy will get taxed in the same year of its receipt by the policyholder or the nominee.
• In case the policyholder suffers from any critical illness (listed under Section 80DDB) or disability (mentioned under Section 80U), the limit is 15%.
• In an unfortunate event of the death of the insured, when the nominees receive the income from the policy, the entire amount is tax-free when in the hands of the candidate. This includes the situation where the insurance premium paid in a financial year is more than the recommended percentage of the sum assured.
• According to 194DA of the Indian IT (Income Tax) Act, the amount received by an insured person for an insurance policy is subjected to tax deduction at source (TDS) if the mentioned amount is not exempted under Section 10(D).
• The percentage of the received amount that is subjected to TDS is 2%. If the policy income is tax exempted under Section 10(D), the amount will be given to the policyholder without any application of TDS.
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Prime Tax Benefits of Insurance Policies
The life insurance policies have more tax benefits. In these policies, the sum assured is very high, and it is several times the multiple of the annual premium paid. There is no maturity benefit on the life insurance plans.As per the IRDA guidelines, if a policyholder aged 45 years or below buys an insurance policy with a ten-year period, he will receive a sum assured that is ten times more than his annual premium. This will make the policyholder eligible for tax benefits.If the policyholder is more than 45-year old and if his policy term is less than ten years, the sum assured will be limited and the insured person will not be eligible for tax deductions.
Several insurance companies now offer customised plans where the customer can choose his sum assured as per his convenience. A life insurance policy is a long-term commitment. Choose the right one based on your investment needs and the features. The choice of the life insurance policy should not be based out of tax benefits alone.
(The author is Founder & CEO, PolicyX.com)