Tax laws allow certain tax benefits for premium paid for life insurance polices as well as in respect of money received from life insurance company. Let us discuss.
Tax benefits for life insurance premium paid
An individual whether resident of non-resident and an HUF can claim deduction for life insurance premium paid under Section 80 C upto Rs. 1.50 lakh every year. This deduction is available along with other eligible items like PPF, NSC, ELSS, home loan repayment, tuition fee paid, provident fund contribution etc. Deduction for life insurance premium paid is upto 10% of the sum assured and for any premium paid over 10% the deduction is not available. However, in case the policy is taken for a handicapped person or one suffering from critical illness the premium upto 15% is allowable.
Persons and type of policies for which the deduction is available
An individual can claim this deduction for his own life insurance policy as well as of his/her spouse. Deduction is also available for premium paid for any child of the Individual whether financially dependent or not. So the non-earning parents who are senior citizen and do not have many items available for deduction under Section 80C except tax saving FD, NSC and deposits under Senior Citizen Saving Scheme can pay the premium for their earning children to optimize the tax outgo, whose limit of Section 80C in all likelihood gets exhausted earlier due to mandatory payments like PF, tuition fee and home loan repayment.
This deduction is available for all types of life insurance policies like term plan, whole life policies, endowment plans and Unit Linked Polices(ULIPs) subject to the cap of 10% of the sum assured.
Tax benefit for money is received from insurance company
The money received from insurance company at the time of death of the policy holder is fully tax free under Section 10(10D) for all type of insurance policies including single premium policies andULIPs.
However, in respect of money received otherwise than on death, it is exempt only if the premium for the policy did not exceed 10% of the sum assured for any of the year during the premium paying term for all policies issued after 1-4-2012. However, for polies issued for handicapped persons or those suffering from critical illness a higher threshold of 15% is provided. For the policies issued between 1-4-2003 and 31st March 2012 a higher percentage of 20% is allowed. The money received in respect of policies issued prior to 1st April 2003 is fully tax exempt.
What are the rules for single premium policies?
For single premium polies the premium paid in all the probability would be more than 10% of the sum assured so the deduction under Section 80C would be restricted to 10% of the sum assured in the year of payment. Since exemption under Section 10(10D) is available only if the premium paid does not exceed 10% of the sum assured, the money received under single premium policy otherwise than as death claim would not be tax exempt in case the premium paid exceeds 10% of the sum assured.
It may be noted that the entire money received on maturity of such policies would not be taxable but only the difference between the premium paid and money received can be taxed. Income tax law does not have any specific rules on how the profits on such life insurance polices are to be taxed. In my opinion the premium paid can be treated as investments and if the policy ran for more than 36 months, the same can be treated as investment and only the indexed gain can be taxed at flat 20%.
What are the rules for ULIP policy as regards money received?
The money received from insurance company is tax free for all ULIP policies issued prior to 1stFebruary 2021 provided the premium paid did not exceed 10%/15% of the sum assured for any of the premium paying term. However, the ULIP policies issued after 1st February 2021 will not enjoy this exemption if the premium paid for such polices for any of the year exceeded 2.50 lakhs during the year.
The same would be taxed as listed shares/unit of equity oriented schemes and the difference will be taxed at flat rate of 10% after initial one lakh if the equity component in the scheme was at least minimum of 65% for all the years. If the ULIP did not have this minimum 65% of equity holding during the entire tenure, the difference would be treated like single premium policy as discussed earlier.
Balwant Jain is a tax and investment expert and can be reached on email@example.com and @jainbalwant on twitter.