Whether you are planning on buying a house, embarking on a new career path or just drawing lines for your children’s future, this hoary advice rings your ears: “Do your best, but be prepared for the worst.” Of course, you have paid heed to it and that’s the reason why you have bought insurance policies. You can take a bow.
While there is much to be said about life insurance and its benefits in terms of tax and coverage, in this piece we let you in on a little secret: how they are taxed.
Tax consideration for Traditional Insurance Plans and ULIPs
Upon death of the Policyholder: In case of death of the policyholder, the proceeds of the policy are given to the family members or nominees. The money thus given to the nominee is completely free from tax under Section 10 of the Income Tax Act.
Upon maturity: One good thing about traditional life insurance plans and ULIPs is the fact that apart from offering protective coverage during the policy tenure, there is no tax liability on you when you receive the policy proceeds at maturity.
Upon surrendering policy before maturity: If you are opting for a premature surrender of your policy, the overall tax liability will depend on the number of premiums you have paid to the company. If you have paid a minimum of five premiums, you will have no tax liability. On the other hand, if you have not paid this minimum number, then the surrender value of the policy gets added to your total income for that financial year. Depending on your net income including the surrender value, you are then liable to pay income tax as per your income tax bracket.
Tax consideration for Pension Plans
Pension plans have their own unique advantages, however are not very tax-friendly as far as the returns are concerned.
Upon death of the Policyholder: In the unfortunate case of demise of the pension plan holder, the family member or the nominee of the policy gets the proceeds as per the pension plan. The money received is completely free from any tax liability as per Section 10(10D) of the income tax act.
Upon surrendering policy before maturity period: If you surrender a pension plan before its actual maturity date, all the premiums claimed as deduction under Section 80C will be reversed. This is a big deterrent for people to surrender their pension plan mid-way. The surrender value also gets added to the annual income of the policyholder and tax needs to be paid depending on the taxation bracket the policyholder falls under. As per the latest rules by IRDA, any individual opting out of a pension plan midway must use 2/3rd of the surrender value to purchase annuity plan.
Upon maturity: For pension plans you can withdraw only 1/3rd amount as tax-free, while the remaining 2/3rd of the maturity proceeds must be used for compulsory purchase annuity plans. On the positive side, one starts to get regular pension from this corpus post maturity. The pension however thus received is treated as income and is liable for tax as per the prevailing income tax bracket.
Taxation aspects that you didn’t know about Life Insurance
- It is not generally known to many that your spouse or children too can pay the premium for you and still you can claim tax benefit for that. So, the next time there is any shortfall in your account to pay the premium, worry not.
- If you think that premiums paid up to Rs 1,50,000 is fully taxable, again you are wrong. As per the amendments applicable from April 1, 2012, any premium paid in a year which is in excess of 10% of the sum assured of that policy is not allowed deduction under Section 80C. The sum assured here is the minimum amount company has agreed to pay you, excluding any bonus (as per Section 80C (3) and 3(A) of the Income Tax Act).
- If in case, at any point you are taxed for the maturity benefit received from a life insurance policy, read this before you jump out to claim a refund. For life insurance policies issued in between April 2003 and March 2012, any amount received other than on death benefit, shall be taxable, if the premium payable for this policy exceeds 20% of the sum assured in any of the years. Post March 2012, the taxation affects you if it is above 10%.
So before opting for any life insurance policy, it is important that you understand not just the tax benefits, but the liabilities too. This helps avoid unpleasant surprises later.