Analyzing taxability and tax benefits of Life Insurance Policy

What is Life Insurance?

Life insurance is a legally binding contract drawn between a policyholder and an insurance company. The purpose of it is to serve as a sinking fund. A considerable amount of money also known as the death benefit, is issued to the family of the bereaved upon the death of the insured person. This is done in exchange for the premium payments made under different categories of life insurance policies by the individual.

Can you possess more than one life insurance policy?

Yes, it is legally possible to hold as many insurance policies as you please. This is where group life insurance offered by an employer for his whole company comes into the picture. But this policy does not have maximum coverage. Depending on the additional coverage you require, you can opt for a new policy rather than increasing the coverage on the policy you are already holding. This would ultimately cost you less and add more benefits to your plate.

Understanding Section 10(10D)

As per the Income Tax Act 1961, the provisions of Section 10 (10D) offer tax exemption on the premiums paid to the insurance policy or the actual sum assured when the policy matures, along with policy proceeds for the nominee adhering to the conditions that fall under it. This exemption is also applicable for the returns earned from a Unit Linked Insurance Plan (ULIP) and Single Premium Life Insurance. It should be noted that provisions under Section 80C provide only deductions, whereas provisions under Section 10(10D) offer exemptions. These exemptions can be availed for all life insurance payouts.

Moreover, there is no specified upper limit of exemption under this Section.

Conditions for tax exemption under Section 10(10D) for term insurance policy

• The premium payable for the policies bought between the period of 1st April 2003 and 31st March 2012 should not be more than 20% of the sum assured.
• For every policy that is purchased after 1st April 2012, the amount paid periodically to the insurer should not be more than 10% of the sum assured. In other words, the actual capital sum assured must be at least ten times the amount being paid as a premium.
• The premium payable for any year during the term of the policy should not exceed 20% of the capital sum assured.
• The premium payable for a definite number of years crosses 15% of the assured sum of capital under two conditions:
  • If the policy is taken for an individual with some time acute disability as per Section 80U.
  • As per the conditions listed on Section 8DDB, if the policy is taken for an individual with a disorder or suffering from an ailment.
• Tax Deducted at Source (TDS) of 1% is applied when the compensation amount received on policies that do not come under Section 10(10D) exceeds rupees 1,00,000 by the company before making the payment. The PAN of the policyholder is also made available to the insurer.

Tax Exemptions for ULIP Plans Under Section 10(10D)

In order to claim an exemption for the term insurance policy under section 10(10D), the following conditions must be met -

• For the policies issued after April 1, 2012, the life insurance premium should not exceed 10% of the actual sum assured.
• The amount of life insurance premium should not be more than Rs.2,50,000 for ULIP policies and Rs.5,00,000 for the other policies issued after specified dates.

Understanding Section 80C

Section 80C came into effect in the year 2006 and it is the most favored and the popular of all the tax-saving options made available. Deductions under this Section permit the taxpayer to claim a maximum deduction of rupees 1.5 lakhs from the individual’s annual income. The taxpayers can make eligible investments in life insurance, Public Provident Fund, different savings schemes etc. or carry out some expenses that will help them save on the taxes they pay.

Eligibility and conditions for tax exemption under Section 80C for term insurance policy

• The deduction can be claimed by an individual or a HUF.
• While premiums paid for self, spouse, and dependent children qualify for the deduction, premiums paid for parents cannot be claimed as a deduction.
• However, for HUFs, premiums paid for any member of the family can be claimed as a deduction.
• For policies issued on or after 1st April 2012, the premium should not exceed 10% of the death sum assured. However, if the plan is issued before this date, the premium should not exceed 20% of the death sum assured.
• The policy should be active for a minimum of two years. If the life insurance policy is surrendered within two years, the deduction would be reversed. The deduction you claimed would be added back to your income and taxed in the year when you surrender the policy.
• The above duration of 2 years is applicable for non-linked policies. For ULIP policies, this duration is 5 years.