Saving income tax cannot be the sole motivation for buying a life insurance policy or paying insurance premium, even though there is a general impression that life insurance is a tool to escape the income tax liability to a large extent. But this is a highly misplaced notion. If the life insurance business has grown at a fairly impressive rate in our country it is mostly because of the hard work carried out by the millions of agents and lakhs of employees of insurance companies including LIC, who have carried the message of financial security through life insurance to almost each household in urban as well as in rural areas.
The exceptionally high productivity of insurance sales persons during the last quarter of a financial year, however, gives credence to the belief that life insurance is sold for saving personal tax only. It is partially true that during the last quarter most people focus on sale and purchase of life insurance for such benefits. There is definitely a large group of people who would like to minimise tax liability by paying life insurance premium in the relevant year.
Insurance and tax benefit
Section 80C of the Income Tax Act, 1961 provides for deduction from income on premium paid to buy and keep in-force the life insurance policy on the life of self, spouse and children. Under this section the maximum permissible deduction is up to Rs 1.5 lakh. However, the ceiling is inclusive of investments made in deferred annuity policies and contributions to provident fund, investment in ELSS of the mutual funds. This includes premium paid under group savings linked insurance schemes.
The main reason for buying a life insurance policy should be the human life value which would require to be substituted through the policy in case the insured dies during his earning period. The premium amount eligible for such deductions from income cannot be more than 10% of the sum assured. However, individuals who suffer from serious disability or disease may avail themselves of deductions from premium to the extent of 15% of the sum assured. For policies issued before April 1, 2012 the deduction is fixed at 20% of the sum assured.
Terminating a policy
Policyholders cannot get away with the deductions from taxable income if they terminate a policy immediately in the next few years for which deductions have already been claimed. In case of life insurance policy taken through single premium mode, do not surrender the policy before completion of two years from the date of first premium received. For ULIPs, minimum retention period is five years and for others, minimum period is two years.
Some life insurers offer health insurance or critical health insurance cover as an add-on benefit under the life insurance policy. Policyholders can claim separate deduction of up to Rs 25,000 under Section 80D. The amount may go up to Rs 30,000 in case a senior citizen holds such policy. Those who pay premium on behalf of parents may also claim such deduction.
Tax-free maturity proceeds
The maturity proceeds received by the policyholders or their nominees/successors, respectively are fully exempted from tax liability under Section 10 (10D). However, maturity proceeds in respect of Keyman insurance policy under Section 80DD are not exempted from income tax.
Life insurance is a convenient tool for providing financial security to the dependants of the earning members of a family. The tax exemptions are only incentives given by the government for encouraging people to buy life insurance in the absence of comprehensive social security system.
Income tax benefits should never be considered as a reason for buying life insurance. Those who think that the business of life insurance survives on tax efficiency need to correct their understanding of the wonderful financial tool.
-The writer is former MD & CEO, Star Union Dai-ichi Life Insurance. His new book ‘The LIC Story: Making of India’s Best-known Brand’ is on the stands now.