In India, insurance products are one among the popular tax saving instruments. Under Section 80C of the Income Tax Act, life insurance premium up to a maximum of Rs 1.5 lakh per financial year qualifies for a tax deduction. Most of us postpone tax planning till the fag end of March. When the financial year end approaches, most of us fall prey to the best sales presentation from a financial intermediary without understanding the product features completely and buy a product whether it suits our needs or not.
Certified Financial Consultants often suggest that customers should not mix their insurance and investment needs. Even then, in the rush to meet 80C tax deduction limit targets, most of us end up buying insurance products such as unit-linked insurance plans (ULIP) and endowment plans that offer the dual benefit of insurance and investment.
We will discuss the tax implications of Life Insurance with reference to IRDAI Regulations and Income Tax Act.
Life insurance premium which is tax deductible under Section 80 C
Any amount paid towards life insurance premium for yourself, your spouse and children qualify for deduction under Section 80C. However, the premium paid by you for parents/brothers/sisters/in-laws is not eligible. Please note tax deduction is subject to an overall ceiling of Rs 1.5 lacs under Section 80C (Which includes the contribution to PPF, EPF, Housing Loan principal, ELSS etc.,)
Criteria for eligibility for tax exemption under Section 80 C
A common perception is that the entire life insurance premium qualifies for a tax deduction. However, that is not the case. Not all life insurance premium paid is tax deductible. If the policy on or after April 1, 2012, annual premium up to a maximum of 10% of Sum Assured is tax deductible.
Let’s consider an example. If you purchase an insurance policy with a sum assured of Rs 4 lacs and an annual premium of Rs 50 Thousand, only Rs 40,000 (10% of Sum Assured) is tax deductible. You won’t get any tax benefits for the balance premium. Any premium in excess of the aforesaid limit (10% of the Sum Assured for the new policies) shall not qualify for tax deduction under section 80C of the Income Tax Act.
An additional relaxation of 5% (i.e. up to 15% of Sum Assured) is available to a person suffering from a disability or severe disability (as specified under Section 80 U) or to those suffering from a disease or ailment as specified under Section 80DDB.
Let’s consider an example. If you purchase an insurance policy with a sum assured of Rs 3 lacs and an annual premium of Rs 50 Thousand, only Rs 45,000 (15% of Sum Assured) is tax deductible. You won’t get any tax benefits for the balance premium.
Tax Deductions on Premiums Paid for Life Insurance under Section 80D
Under Section 80D of the Income Tax Act, 1961 allows tax benefits on health insurance premium. So, if your life insurance plan has health-related inbuilt or add-on cover such as Critical Illness Rider, Surgical Care Rider, Hospital Care Rider, etc. you can avail tax benefits.
Who can you avail this benefit?
You can claim deductions for premiums paid towards health insurance policies of Yourself (assessee), Your spouse, Your dependent children, Parents (whether dependent or not)
Few things to keep in mind about tax exemption in life insurance under Section 80D:
The maximum limit on premiums: The tax deduction can be only availed for an amount up to Rs.25,000/-. On Self, Spouse and Children.
The maximum limit on Life Insurance premiums paid for your dependent parents: If you are paying premiums for a health insurance policy that’s in your parent’s name, you can avail an additional tax deduction benefit of Rs.25,000/-.
The maximum limit on Life Insurance premiums paid for dependent senior citizens: If you are paying premiums for a health insurance plan in your senior citizen parent’s name, you can avail tax benefit on the same to an amount up to Rs.30, 000.
Moreover, a member of the Hindu Undivided Family (HUF) can also avail the above tax benefits under this section.
Section 10(10D): Tax Exemption on Maturity Amount of Life Insurance Policy
Getting tax deductions on insurance premium payments is one part. Another common perception is that the maturity proceeds from life insurance products are exempt from tax too. This is also not true.
As per Section 10(10D) of the Income Tax Act, 1961, any sum received under a Life Insurance Policy, including the sum allocated by way of bonus on such policy is exempt from tax whether received from India or any Foreign Company. However, this rule does not apply to the following amounts:
- The sum received under Section 80DD (3) or 80DDA (3), or
- Any sum received under a Keyman Insurance Policy, or
- Any sum received other than as death benefit under an insurance policy which has been issued on or after April 1, 2003 and if the premium paid in any of the years during the term of the policy is more than 20% of the Actual Capital Sum Assured.
- The Finance Bill, 2012 has proposed that the exemption under Section 10 (10D), on benefits you receive under life insurance policies issued on or after April 1, 2012, shall be available only if the premium payable in any of the years is not more than 10% of the Sum Insured. Hence, for any new policy purchase, where the annual premium for any year during the term of the policy exceeds 10% of the sum assured, the insurance proceeds (other than in case of death) will be taxable. The insurance proceeds shall be taxed at policy holder’s marginal income tax rate (as per income tax slab).
Early surrender/termination of life insurance products
As per Section 80C of the Income Tax Act, if surrender a ULIP before paying the premium for five years, the aggregate amount of tax deductions allowed in the previous years for payment of life insurance premium shall be disallowed. The income for such previous years shall be adjusted accordingly and the policyholder will have to pay tax accordingly. For insurance products other than ULIPs, the premium must be paid for at least 2 years to avoid reversal of tax benefits taken in the previous years. For single premium policies, the insurance contract should not be cancelled within two years of commencement of insurance to avoid reversal of tax benefits.
Hence, you must exercise extra caution. If you purchase a wrong insurance product, you can either terminate the policy and forgo the tax benefits claimed in the previous years or continue with the wrong product for the minimum number of years. The insurance products are typically front-loaded i.e. charges are higher in the earlier years. Therefore, if you surrender before the minimum prescribed period, not only do you forgo the tax benefits but also take a hit on your returns due to higher charges in the initial years.
TDS on insurance proceeds
Most policyholders are not aware of these conditions. Thus, they are likely to fall short of tax compliance. Till now, there was no easy way for even the taxman to find out about your non-compliance. However, in the budget 2014-2015, the government moved to plug in this gap by introducing a provision for tax deduction at source (TDS) of 2% if the insurance proceeds are not tax-exempt. Now, the onus is on the insurance company to deduct TDS of 2% if the insurance proceeds are not tax exempt. This will leave a trail for the income tax department to follow to your doorsteps and send a tax demand. No TDS shall be deducted if the maturity proceeds are less than Rs 1 lac.
Goods and Services Tax rates
The government has introduced Goods and Services Tax (GST) on the taxable value of services, effective from July 1, 2017.
GST to be charged and collected from policyholders are as follows:
|Term insurance premium||18%|
|Health insurance premium||18%|
|Annuity: Single Premium||1.80%|
|Endowment: First year premium||4.50%|
|Endowment: Renewal premium||2.25%|
A financial product’s tax structure is one of the critical elements that are considered before the purchase of a financial product. However, you must never purchase an insurance product just to save taxes.
You need to understand that purchase of a life insurance product involves a long-term commitment to pay the annual premium. If you realize that you have purchased a wrong product, even termination of such insurance plans shall have unintended tax consequences as discussed above.
About the Author:
Mr. Paramesh Kumar S has a diversified work experience of 27 years. He has worked with McMillan Press as an Editor for 2 Years, 22 Years in various Capacities in leading Insurance Companies including LIC, HDFC, Reliance, Exide Life. He was heading South India for Training needs of Apps Daily, an App. Company, before joining Manipal.
Currently, he is associated with MABFSI since November’16 as Assistant Professor with Life Insurance vertical.