People commonly believe that life insurance policy proceeds are completely tax-free. However, various restrictions and exceptions apply to this. To take advantage of the 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 policy are taxed.
Tax treatment varies for pension arrangements, some of which include a life insurance component. A life insurance calculator is a tool you may use online to determine the amount of coverage required based on your needs.
The Income Tax Act of 1961 contains Section 10(10)D.
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 upon the passing away of the insured, are totally tax-free for the recipient.
In the following circumstances, the insured will owe taxes on these policy proceeds:
- Per section 10(10D), if the premium payable in any year exceeds 20% of the actual sum assured, the insurance policy proceeds 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 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. Furthermore, excluded from the “actual sum assured” are any premiums that will be reimbursed to the policyholder. **
- 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 policy 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, if the insured passes away and his nominees receive the insurance proceeds, they will be tax-free in their hands even if the premiums paid in any given year exceed the required threshold as a percentage of the sum promised.
Keyman 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 plan proceeds is also 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%. It is also important to note that the tax status of life insurance plans purchased from foreign insurers (those not registered in India) may include extra conditions that vary from case to case.
The taxability of life insurance policy payouts depends on various factors, such as the type of policy, the amount of the payout, the beneficiary designation, and the purpose of the payout. Moreover, if the policyholder has named their estate as the beneficiary, the payout may be subject to estate taxes. It is important for individuals to understand the life insurance tax benefits of their life insurance policies and seek advice from a financial advisor or a tax consultant.
A life insurance calculator is an easy-to-use tool to check the amount of premium you would have to pay.