After religiously paying your life insurance premiums, the time may be nearing for your policy to mature. Whether it is a money-back or an endowment plan, all traditional life insurance policies have a maturity value to be received by the policyholder on surviving the term of the policy.
And, if you had purchased the policy 10-15 or 20 years back, there have been several tax-related changes during the years. So, will you be required to pay tax on the maturity proceeds? Before we see that, let’s see what the maturity proceeds will consist of.
Life Insurance Maturity Amount
In a typical traditional policy, the maturity amount comprises two components – One is the amount of sum assured and second is the total of bonuses accrued ( in a with-profit plan) over the years.
Illustratively, if you would have bought a Rs 3 lakh policy for 20 years, by paying an annual premium of about Rs 15000, you will get the assured amount of Rs 3 lakh on maturity. Over and above that, based on the bonus declared by the insurer during these 20 years, the bonus amount gets paid on maturity.
Assuming, a bonus of Rs 45 per lakh for each year, yearly bonus amounts to Rs 13500 and total accrued bonus after 20 years is about 2.7 lakh. So, on maturity, policyholders get Rs 3 lakh ( sum assured) plus Rs 2.7 lakh (bonus) equal to Rs 5.7 lakh.
Life Insurance Tax Rules
As per Section 10(10D) of the Income Tax Act, the sum assured received on maturity or surrender of a policy or upon the policyholder’s death is completely tax-free. Bonuses received with such an amount are also exempt under Section 10(10D).
However, an important condition has to be met before availing the benefit under Section 10(10D) – the ratio of premium to sum assured has to be within a specific limit as set by the income tax department. This ratio was modified over the years and, therefore, will depend on whether one has purchased policy before or after 1 April 2012.
Here is the condition – For policies issued after 1 April 2012, if the premium paid on the policy does not exceed 10% of the sum assured, any amount received on maturity of a life insurance policy or amount received as bonus is fully exempt from Income Tax under Section 10(10D).
For policies issued before 1 April 2012 (after 1.4.2003), it was 20% of sum assured, i.e. the sum assured has to be at least 20 times the premium
So, if you are paying an annual premium (after 1 April 2012) of Rs 1 lakh, the minimum sum assured has to be kept at Rs 10 lakh. In other words, if the sum assured is Rs 10 lakh, you need to pay a minimum premium of Rs 1 lakh to keep enjoying the tax-free benefit on maturity. In the example above, one may pay a lower premium of say Rs 50,000 and yet keep a sum assured of Rs 10 lakh but anything above Rs 1 lakh for a sum assured of Rs 10 lakh will make the policy devoid of tax-free benefit.
In nutshell, the annual premium paid should be less than 10 percent of the sum assured or the sum assured is at least 10 times the premium for policies issued after 1 April 2012.
Other Tax Benefits
As far as Section 80C is concerned, the same ratio needs to be maintained so that the tax benefit may be enjoyed. Deduction is restricted to 20% of capital sum assured in respect of policies issued on or before 31-3-2012 and 10% in case policies issued on or after 1-4-2012.
Therefore, while the maturity proceeds including bonus and sum assured of traditional insurance plans are tax-free in the hands of the policyholder, subject to fulfilling the above conditions, in the case of Ulips, there has been a recent tax change. Budget 2021 had introduced tax on gains made in Ulips issued on or after February 1, 2021 with an annual premium of Rs 2.5 lakh, the return on maturity shall be treated as Capital Gain and charged accordingly under section 112A.