All of us want to pay as little tax as possible from our income. Hence we look for tax-saving investments and products so that we can maximise the available tax exemptions.
Life insurance plans are one such product which provide the benefit of tax exemptions. Let’s explore their tax benefits in detail.
What are the tax benefits available for life insurance plans?
Life insurance plans give you tax benefits under various sections of the Income Tax Act, 1961. These include the following –
The premiums you pay for life insurance policies (except for pension plans), would be allowed as a tax deduction under Section 80C of the Income Tax Act, 1961. The maximum limit of deduction which is allowed under Section 80C is INR 1.5 lakhs in a financial year.
This section deals specifically for premiums paid towards pension plans. Such premiums qualify for a tax deduction under Section 80CCC. The maximum limit of deduction available under this section includes the limit under Section 80C. As per the Act, the maximum limit under Sections 80C and 80CCC combined should not exceed INR 1.5 lakhs in a financial year.
Section 80D deals with premiums paid towards health insurance coverage. If you buy a health insurance policy offered by a life insurance company or choose a health-related rider benefit with the life insurance plan, you can avail the benefit of this section. The premium paid for the health plan or the rider benefit would be allowed as a tax deduction under Section 80D. The maximum limit of deduction which is allowed is INR 25,000 which increases to INR 50,000 if you are a senior citizen.
This section allows tax reliefs on the benefits which you receive under your life insurance plan. The death benefit or the maturity benefit would be tax-free in your hands under this section. Moreover, any surrender benefit that you receive or partial withdrawals you make under unit linked plans would also be allowed as a tax-free income. The best part about this section is that there is no maximum limit on the tax-free income. The entire amount of benefit that you receive is allowed to be tax-free.
This section, again, is specifically for pension plans. Under such plans, 1/3rd of the corpus accumulated on maturity is allowed to be withdrawn as a lump sum in cash. This is called commutation of pension. The rest has to be converted to an annuity. Section 10(10A) allows the value of the commuted pension to be a tax-free income in your hands.
Who is eligible to avail tax benefits?
Individuals (both resident and non-resident) and HUFs (Hindu Undivided Families) can avail tax benefits on the premiums paid and benefits earned from a life insurance policy. In case of individuals, tax benefits are available if the premium is paid for self, spouse and dependent children. For HUFs, the benefit is available for premiums paid for any member of the HUF.
Qualifying conditions for the tax benefit
If you are excited about investing in a life insurance policy after knowing about the various tax benefits discussed above, hold your horses.
While life insurance plans do allow the above-mentioned tax benefits, there are some qualifying conditions associated with such benefits.
Conditions on premiums paid with respect to Section 80C:
- The premium should be paid within the same financial year in which it is claimed as a deduction. For instance, if you want to claim a deduction for premium paid in the financial year 2017-18, the premium should be paid anytime between 1st April 2017 and 31st March 2018. If the due date is March 2018 and you pay the premium after the due date (but within the grace period) in April 2018, you would not be able to claim Section 80C benefit on that premium for the financial year 2017-18. This premium would be allowed as a deduction in the year 2018-19, i.e. in the year in which it is actually paid.
- If the policy is issued on or before 31st March 2012, the premium should not be more than 20% of the sum assured. If the premium is more than 20% of the sum assured, tax deduction would be applicable only up to 20% of the sum assured. For instance, if the sum assured is INR 1 lakh, the premium should be up to INR 20,000 to be eligible for a full tax deduction. If, however, the premium is INR 25,000, tax deduction would be allowed only up to INR 20,000.
- If the policy is issued on or after 1st April 2012, the premium should be up to 10% of the sum assured. In case it exceeds 10% of the sum assured, a deduction would be limited to 10% of the sum assured. In the same example of INR 1 lakh sum assured, premiums up to INR 10,000 would be fully allowed as a deduction under Section 80C. However, if the premium is INR 12,000, a deduction would be allowed only on INR 10,000.
- If the insured has a disability specified under Section U of the Income Tax Act, or the insured suffers from a severe disease specified under Section 80DDB and Rule 11DD, the rule is different. In such cases, if the policy is issued on or after 1st April 2013, premiums up to 15% of the sum assured are allowed as deduction. So, if the sum assured is INR 1 lakh, premiums up to INR 15,000 can be claimed as income tax deduction.
Conditions on the surrender benefit of insurance policies:
While you know that life insurance policies allow surrender, what you might not know is the tax treatment of the surrender benefit. You can get the surrender benefit to be tax-free under Section 10(10D) but there are conditions involved for availing a tax-free surrender benefit.
If the conditions are not fulfilled, not only is the surrender benefit treated as an income in your hands, the earlier tax deduction under Section 80C (on premiums) is also reversed. You are taxed on the premium deduction which you availed in earlier years when you surrender the plan without meeting the specified conditions.
If you want to avoid such taxation, here are the clauses associated with the tax treatment of surrender benefit –
- If you bought a single premium policy, the policy should be surrendered only after the completion of the first two policy years
- If you bought a unit linked policy, the policy should be surrendered only after the completion of the first five years of the plan
- If you have bought any other life insurance policy, the policy should be surrendered only after the completion of the first two years of the policy.
If these conditions are not met, the surrender value would not be allowed as a tax-free benefit under Section 10(10D).
Conditions for the maturity/death benefit under Section 10(10D):
The maturity and death benefits would be allowed as tax-free incomes under Section 10(10D) only if the following conditions are met –
- If the policy is issued on or after 1st April 2003 but on or before 31st March 2012, the sum assured should be at least 5 times the premium amount to qualify to be tax-free under Section 10(10D). If the sum assured is below 5 times the premium, the entire benefit would be taxable. For instance, if the premium is INR 10,000, the sum assured should be INR 50,000 and above. If the sum assured is INR 40,000, then the maturity benefit would be completely taxable in your hands.
- If the policy is issued on or after 1st April 2012, the sum assured should be a minimum of 10 times the premium amount to qualify to be tax-free under Section 10(10D). If it is not, the entire policy proceeds would be taxable, For instance, if the premium is INR 10,000, the sum assured should be INR 1 lakh and above. If it is below this amount, the maturity benefit would be fully taxable.
- In the case of individuals with severe disabilities under Section 80U or diseases under Section 80DDB and Rule 11DD, if the sum assured exceeds 15% of the premium, the entire maturity benefit would be taxable.
- The death benefit, however, is tax-free in all cases even when the sum assured does not meet the minimum multiple criteria.
If all the above-mentioned conditions are fulfilled, a life insurance policy becomes an EEE product. The premiums paid are exempted from tax, any bonus or additions earned are exempted from tax and also the plan benefits are exempted from tax.
If you are wondering that there are other investment avenues which also give you tax benefits, here is a comparative analysis –
|Investment avenue||Tax treatment on investments||Tax treatment on returns|
|Fixed deposits||Investment is taxable. For 5-year Tax Saving FDs the investment is allowed a tax deduction under Section 80C.||Returns are fully taxable|
|PPF||Investment upto Rs 1.5 lakhs is tax-free under Section 80C||Returns are tax-free|
|ELSS||Investment upto Rs 1.5 lakhs is tax-free under Section 80C||Returns are tax-free up to INR 1 lakh. If the returns exceed INR 1 lakh a flat rate of tax of 10% is charged on the excess returns|
|Savings account||Investments form a part of taxable income||Interest earned up to INR 10,000 is tax-free under Section 80TTA|
|Life Insurance||Premium is tax-free under Section 80C||Maturity Benefit is also tax-free under Section 10(10)D provided the sum assured is 10 times the premium paid|
Life insurance policies give you certain tax exemptions. However, the underlying conditions need to be remembered to understand the exact tax benefits which you can avail.
Should one buy life insurance plans just to save taxes?
First of all the only life insurance you should consider buying should be a term plan (and not ULIPs, Endowment plans etc).
Secondly, dont buy life insurance just to save taxes. Life Insurance should be bought for the purpose of life coverage. Tax benefit is an additional advantage that you can get from Life Insurance Policies, which makes it tax efficient.
Taxation should not be the only parameter for choosing an investment or insurance product. The primary criteria should be your need for that product (life insurance in this case) and whether the said product actually solves that need in an efficient way.