Purchasing an online life insurance? It is a good move, considering the uncertainty of life and all the vagaries it brings in its wake. A life insurance policy will secure your family financially in case of your unfortunate demise within the policy tenure. With the passing away of the primary income earner of a family, there is a huge struggle to make ends meet at such a stressful time. Life insurance is what cushions the financial impact, at least. As you may already know, various types of life insurance policies exist.
On the one hand, pure life insurance, like term insurance, is affordable and comes with the lowest life insurance premiums for comparatively higher coverage. On the other end of the spectrum, you will find ULIPs (unit-linked insurance plans) and endowment plans that combine investments and insurance. Both of these policy types offer maturity benefits which are paid if the policyholder survives the term of the plan. The amount may be deployed likewise for meeting diverse future life goals. In addition, term insurance policies pay a sum assured to the nominee of the policyholder in case of demise within the policy period. Such payouts can be hugely beneficial for families in varying situations. However, the key question is whether an additional tax burden accompanies them. Here’s looking at the same in this article.
Taxation aspects for life insurance payouts
In most scenarios, there is no additional tax burden on life insurance payouts. There is a provision for Section 10 (10D) of the Income Tax Act of 1961 that clarifies the same. Here are a few points worth noting in this regard:
- Death Benefits- As per Section 10 (10D) of the Income Tax Act, any death benefit paid by the insurance company to the nominee upon the demise of the policyholder is exempted from taxes. To illustrate this concept, suppose a policyholder has a term insurance policy of Rs. 40 lakhs and passes away within the policy duration. The nominee will get the entire amount, i.e. Rs. 40 lakhs, as the tax-exempt sum assured as per Section 10 (10D).
- Maturity Benefits- Term insurance only offers death benefits to the nominees of policyholders. However, other life insurance plans have accompanying maturity benefits or payouts after the policy tenure. These may also payout terminal bonuses or extra bonuses. As per Section 10 (10D) of the Income Tax Act, these payouts are also tax-exempted with a few conditions. These conditions have to be met across the entire term of the policy. Maturity proceeds from ULIPs purchased after Feb 2021 are tax-free only if the total premiums paid towards ULIPs in a year do not surpass ₹2.5 lakh.
Life insurance policies issued on or post 1st April 2003 and before 31st March 2012 should have their total annual premiums within 20% of the sum assured. For policies issued on or after 1st April 2012, the premium should be at most 10% of the sum assured.
What this essentially means is that suppose you purchased a policy after 1st April 2012. In this case, if you have a premium amount less than 10% of the sum assured, your proceeds will be tax exempted. For example, suppose you buy an endowment policy with a sum assured of Rs. 20 lakhs, and the annual premium stands at Rs. 2 lakhs. In this case, your maturity proceeds will be tax-free. However, suppose the yearly premium is Rs. 2.5 lakh. It exceeds the 10% rule, and the maturity payout will be taxed based on the applicable tax rates in the maturity year. Expand the definition of the maturity amount to cover the sum assured and the bonuses accrued throughout the policy period. The whole sum will be taxed if the annual premium crosses 10% of the sum assured.
The Government has also proposed a change in the taxation for maturity proceeds as part of the Union Budget for 2023. Taxes will apply for maturity proceeds of all life insurance policies where the annual aggregate premium surpasses Rs. 5 lakhs. However, Union Finance Minister Nirmala Sitharaman has also confirmed that it will not impact the tax-exemption status for maturity proceeds received by the nominee due to the demise of the policyholder.
You should thus choose your life insurance policy carefully, working out the life insurance premium for a specific coverage amount. Proper planning and careful selection will help you stay within the tax-exemption threshold.
