Life Insurance Taxability in India: A Complete Guide

Life insurance is one of the most popular financial products in India. It provides financial security to the policyholder's family in case of an unfortunate event. Apart from the protection it offers, life insurance policies also come with several tax benefits under the Indian Income Tax Act, making them an attractive investment option.

However, the taxability of life insurance varies depending on the type of premium paid, amount of premium, and amount received as a death benefit or maturity benefit. In this blog, we will explore the tax implications of life insurance in India for both policyholders and beneficiaries.

1. Tax Benefits on Premium Paid for Life Insurance

Under the Income Tax Act, 1961, policyholders can claim deductions on the premiums paid towards life insurance policies. These benefits are primarily available under Section 80C and Section 80D.

Section 80C: Deduction on Premium Paid for Life Insurance

• Eligibility: This deduction is available to individuals and Hindu Undivided Families (HUF).

• Maximum Deduction: A maximum deduction of up to ₹1.5 lakh can be claimed under Section 80C, which includes life insurance premiums, Employee Provident Fund (EPF), Public Provident Fund (PPF), National Savings Certificates (NSC), and other eligible investments.

• Conditions:

  • The premium paid should not exceed 10% of the sum assured for policies issued on or after April 1, 2012.

  • For policies issued before April 1, 2012, the premium should not exceed 20% of the sum assured.

  • The sum assured should be at least 10 times the annual premium (for policies issued after April 1, 2012).

Section 80D: Deduction on Premium Paid for Health Insurance

If the life insurance policy is bundled with a health insurance rider, then the premium paid for health insurance can be claimed as a deduction under Section 80D.

• For self, spouse, and dependent children: Up to ₹25,000 (₹50,000 for senior citizens).

• For parents (whether dependent or not): Up to ₹25,000 (₹50,000 for senior citizens).

2. Taxability of Death Benefit Under Life Insurance Policies

One of the primary reasons people buy life insurance is to secure their family's financial future in case of their untimely demise. The death benefit provided by life insurance policies is generally exempt from tax.

Section 10(10D): Tax Exemption on Death Benefit

• Exemption: The death benefit received by the nominee is fully exempt from income tax under Section 10(10D) of the Income Tax Act.

• No Taxation: The entire amount received as the death benefit (i.e., sum assured + bonuses) is tax-free.

• Conditions:

  • If the premium paid is not more than 10% of the sum assured (for policies issued after April 1, 2012), then the death benefit is fully exempt.

  • If the premium exceeds 10% of the sum assured (for policies issued after April 1, 2012), and the policyholder dies, then the death benefit may be subject to tax.

Tax Exemption on Nominee's Income

• If the nominee receives the death benefit, this amount will not be added to the nominee's income and will not be taxed under the head “Income from Other Sources” or “Income from Salary.”

3. Taxability of Maturity Benefit Under Life Insurance Policies

While the death benefit is generally tax-free, the taxability of the maturity benefit depends on certain conditions.

Section 10(10D): Tax Exemption on Maturity Benefit

• Exemption: The maturity benefit (sum assured + bonuses) is tax-free under Section 10(10D) if:

  • The premium paid in any year does not exceed 10% of the sum assured for policies issued after April 1, 2012.

  • The policy is not a keyman insurance policy or a policy of a closely held company.

Taxability in Case of Non-Exemption

If the premium paid is more than 10% of the sum assured (for policies issued after April 1, 2012), the maturity benefit may be subject to tax. However, the amount subject to tax will be the excess premium paid over 10% of the sum assured.

Example:

• If the sum assured is ₹10 lakh and the total premium paid annually is ₹1.5 lakh, then:

  • If the policy was issued after April 1, 2012, and the premium exceeds 10% of the sum assured (i.e., ₹1 lakh), then the excess premium of ₹50,000 is subject to tax.

In such cases, the maturity benefit is subject to income tax under the head Income from Other Sources.

4. Tax on Surrender Value of Life Insurance Policies

If the policyholder decides to surrender their life insurance policy before it matures, the surrender value may be subject to tax, depending on the policy's characteristics and premiums paid.

Taxability of Surrender Value:

• If the policy has been in force for more than 2 years:

  • If the premium paid is within the permissible limits (i.e., up to 10% of the sum assured for policies issued after April 1, 2012), then the surrender value is tax-free.

  • If the premium paid exceeds the permissible limit, the surrender value is subject to tax on the amount that exceeds the allowed premium.

5. Tax on Loans Against Life Insurance Policies

A loan against a life insurance policy is often provided by insurers, and it is essential to understand its tax implications:

• The loan amount is not taxable when you take it against the policy.

• However, if the loan is written off or you fail to repay it, any waived-off amount could be considered as income and taxed accordingly.

6. Tax on Assignment of Life Insurance Policies

If a policyholder assigns their life insurance policy to another person, it may have tax implications. Assignment refers to the transfer of ownership rights of the policy.

• Assignment of policy may attract Capital Gains Tax if the policy is assigned for a monetary consideration and is not exempt under Section 10(10D).

If the policy has a surrender value and is sold or assigned for a consideration, any profit made from the transaction may be considered as capital gain and taxed accordingly.

7. Key Points to Remember

• Death benefit: Generally tax-free under Section 10(10D), provided the premium does not exceed 10% of the sum assured.

• Maturity benefit: Tax-free under Section 10(10D), subject to certain conditions.

• Surrender value: Taxed only if the premium exceeds permissible limits (10% of sum assured).

• Loans against policy: Not taxable unless the loan is written off.

• Assignment: May attract capital gains tax if a monetary consideration is involved.

Conclusion

Life insurance provides a combination of financial security and tax benefits. While the death benefits and maturity benefits are generally exempt from tax, the taxability of the surrender value, loans against policy, and policy assignments depends on various factors. By understanding these tax implications, policyholders can make better financial decisions and maximize their tax savings.

Always remember that tax laws can change, and it is advisable to consult a tax professional or financial planner to understand the specific tax impact on your life insurance policies and make informed decisions.