Taxation of Life Insurance Policies & pension plans offered by insurance companies

Taxation of Life Insurance Policies & pension plans offered by insurance companies

 

In Life insurance policies, premiums are paid at regular intervals during policy term. In return for the premiums paid you get an assurance from the insurance company that if the death of the policy holder happens within the policy term then insurance company gives “death benefit” to family members of the policy holder as compensation for early death. However, if policy holder survives the policy term, then he will be given “survival benefit” to cover risk of dying too late. Apart from this, it may happen that policy holder terminates the policy mid-way before maturity by surrendering the policy – in such a case policy holder will receive “surrender value”. To understand taxation of life insurance policies we need to understand tax implications of each of these components i.e

  • Tax implications on premiums paid in life insurance policy – Part A
  • Taxation of survival benefits from life insurance policy – Part B
  • Taxation of death benefit from life insurance policy – Part C
  • Taxation of surrender value – Part D

PART A:  Tax implications on premiums paid in life insurance policy:

  1. If your policy is issued before 1st Aril 2003, 100% of the premiums paid during the year is eligible for deduction under Sec 80C.
  1. If your policy is issued between 1st April 2003 & 1st April 2012, then deduction under Sec 80C will be restricted to 20% of Sum assured (Sum assured is the guaranteed monetary benefit assured by the company in your policy if policy holder dies within policy term)

For example, if Sum assured in your policy is Rs 1000000 & annual premiums are Rs 25000, then deduction under Sec 80C for life insurance premiums paid will be restricted to 20% of sum assured i.e  Rs 20000.

  1. If your policy is issued after 1st April 2012, then deduction under Sec 80C for annual premiums paid will be restricted to 10% (15% if life insured is disabled or suffering fom specified disease) of sum assured.

For example, if Sum assured in your policy is Rs 1000000 & annual premiums are Rs 25000, then deduction under Sec 80C for life insurance premiums paid will be restricted to 10% of sum assured i.e Rs 10000.

Note that the maximum deduction that you get under section 80C is Rs 150000 for all payments combined. All payments combined meaning you not only get deduction under Sec 80C for life insurance premiums paid for self, spouse Or children but also for other payments like investments in equity linked saving schemes of mutual funds, investment in National Saving Certificates, Principal repayment on housing loan etc. & all these payments combined – maximum deduction under Sec 80C is RS 150000.

PART B –  Taxation of survival benefits from life insurance policy

  1. If your policy is issued before 1st Aril 2003, entire survival benefit from policy will be tax free.
  1. If your policy is issued between 1st April 2003 & 1st April 2012, then survival benefit will be tax free only if the annual premium in such policy does not exceed 20% of sum assured. Otherwise survival benefit will be added to your income and tax as per your tax slab.
  1. If your policy is issued after 1st April 2012, then survival benefit will be tax free only if the annual premium in such policy does not exceed 10% of sum assured. Otherwise survival benefit will be added to your income and tax as per your tax slab.

PART C – Taxation of death benefit from life insurance policy :

On death of the policy holder within policy term, the death benefit received by family members as compensation for your early death will be completely tax free in their hands.

PART D –  Taxation of surrender value :

  • If you surrender your policy within 2 years (5 years in case of ULIP), surrender value will be added to your income as “Income from other sources” and taxed as per your tax slab. In addition to this 80C deduction claimed for this policy will also be reversed and amount will be taxed in the year in which policy is surrendered.
  • If you surrender after 2 years (5 years in case of ULIP) , surrender value will taxed exactly like survival benefit i.e
  1. For policies issued before 1st Apr 2003 surrender value is completely tax free
  2. For policies issued between 1st Apr 2003 & 1st Apr 2012, surrender value is tax free only if premium does not Exceed 20% of Sum assured. Otherwise surrender value will be added to the income and taxed as per tax slab.
  3. For policies issued after 1st Apr 2012 Surrender value is tax free Only if premium does not exceed 10% of sum assured. Otherwise surrender value will be added to the income and taxed as per tax slab.

TDS PROVISIONs:

As we have seen there are cases when survival benefit or surrender value from life insurance policy are taxable. If proceeds received from life insurance policy are taxable, TDS (Tax deducted at source) @ 2% of the proceeds will be deducted by the company and only balance amount will be given to policy holder. However, no TDS will be deducted if the proceeds are less than 1Lac.

Taxation of pension plans issued by life insurance companies:

In a typical pension plan, you invest at regular interval in your working life and out of that amount there will be a corpus that will be accumulated on retirement and from that corpus a regular stream of cashflow (pension) is given in your post retirement period. Now we will look at taxation of each of these components:

  • Taxation of investment made in pension plan:

The investment that you make in your pension plan are eligible for tax deduction under Sec 80CCC. These provisions are similar to provisions we saw for deduction under 80C for life insurance premiums paid i.e for example if the policy is issued after 1st April 2012, then deduction under 80CCC will be ristricted to 10% of premiums invested in pension plan & so on.

Also maximum deduction u/s 80C, 80CCC & 80CCD(1) combined is Rs 150000.

  • Taxation of corpus accumulated on retirement:

1/3rd of accumulated corpus can be removed (commuted) tax free, balance will be used to provide regular cash flows (pension).

  • Taxation of pension received from pension plans:

This regular cash flow (pension) is added to your income and taxed as per slab.

  • Taxation of death benefit in pension plan:

If Death happens within policy term most pension plans from insurance company give death benefit – this will be tax free in hands of family member.

  • Taxation of surrender value if you surrender your pension plan mid – way.

If you surrender policy mid – way, surrender value received will be added to your income and you will have to pay tax on it according to your tax slab.

 

 

About the author: wealth360acadamy

Leave a Reply

Your email address will not be published.