People commonly believe that life insurance policy proceeds are completely tax-free. However, there are various restrictions and exceptions that apply to this. To take advantage of life insurance tax benefits, one must understand when these proceeds are tax-free and when they are not.
Let’s take a closer look at how payments made under a life insurance plan are taxed.
A life insurance calculator is an easy-to-use tool to check the amount of premium you would have to pay.
The Income Tax Act of 1961 contains Section 10(10D).
According to Section 10(10D) of the Income Tax Act of 1961, subject to certain restrictions, the amount of the sum assured plus any bonus (i.e., the proceeds of the policy) given upon the maturity or surrender of the policy or the passing away of the insured, are tax-free for the recipient.
In the following circumstances, the insured will owe taxes on these policy proceeds:
- In accordance with section 10(10D), if the premium payable in any year surpasses 20% of the actual sum assured, the proceeds of the life insurance policy will be taxable in the insured’s hands if it was issued after 1.4.2003 but before 31.3.2012. According to section 10(10D), read with an explanation to section 80C(3A), actual sum assured simply refers to the sum assured that has been paid out the least amount throughout the course of all policy years. It excludes any bonuses that will be paid out in addition to the assured amount. Moreover, any premiums that are to be reimbursed to the policyholder are not included in the “real sum assured.”
- The previously indicated limit of 20% has been lowered to 10% for policies issued on or after 1.4.2012. The 10% limit will increase to 15% for any insured person whose policy was issued on or after 1.4.2013 and who has a severe disability or disease as defined by the Income Tax Act and rules. For this purpose, an illness must be one of those listed in section 80DDB read with Rule 11DD of the income tax rules, such as blindness, and a disability must be one of those listed in section 80U (such as autism or mental retardation).
- The full proceeds from the life insurance plan would be taxed in the year of receipt if the premium payable in any year exceeded the statutory percentage, which is 10%, 15%, or 20% of the actual sum guaranteed, as described in the preceding paragraphs. However, suppose the insured passes away and his nominees receive the insurance proceeds. In that case, they will be tax-free even if the premiums paid in any given year exceed the required threshold as a percentage of the promised sum.
- Insurance policy proceeds are not tax-free. According to section 10(10D) of the Income Tax Act, a policy’s proceeds are not tax-free if it is a Keyman insurance policy.
- The payout of life insurance policy proceeds is subject to TDS. Any amount received by an insured Indian citizen from an insurer under a life insurance policy is liable to TDS @ 2% under Section 194DA of the Income Tax Act, 1961, if the amount is not excluded under Section 10(10D). This indicates that the insured will receive policy proceeds exempt under section 10(10D) without TDS (Tax Deduction at Source). Furthermore, the insurer is not required to deduct TDS while paying the insured, even if the funds are taxable under section 10(10D) but do not exceed Rs 100,000.
It’s crucial for you to be aware that without providing your PAN to your insurance, the rate of TDS in situations where TDS is applicable would be 20% rather than 2%.
Life insurance policy payouts can have tax implications depending on various factors, such as the type of policy, the amount of payout, and the beneficiary’s relationship to the policyholder. Generally, the death benefit paid to the policy’s beneficiary is not taxable as income, but if the policyholder had taken out loans against the policy or had surrendered it for cash value before passing away, some or all of the payout may be taxable.
It is important for policyholders to understand the life insurance tax benefits of their life insurance policy payouts and to consult with a tax professional or financial advisor for guidance. By doing so, they can make informed decisions about their coverage and ensure that their loved ones receive the intended benefits without undue tax burdens. A life insurance calculator is a tool you may use online to determine the amount of coverage required based on your needs.
* Currently, there are 2 tax regimes in India – new and old. To get the tax benefit you desire, choose the correct one after consulting an expert. You can opt for a regime change during the next financial year.