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Tax implications of life insurance policies

Let us now check how these policies are taxed when surrendered before maturity and when kept till maturity

Investment Yogi  |  Hyderabad 

We would know at least one person in our family who has purchased a life policy. It could be traditional policy, ULIP or a Pension Plan. Most of the life policies are purchased for saving tax under section 80C.

Condition for eligibility under section 80C is that premium should not exceed 10% of the sum assured. We just buy these policies in a hurry right before the end of financial year i.e. March 31st.

Before buying them, we only think of the tax benefits or the maturity value. Did we ever think of the taxation aspect of these policies? Let us now check how these policies are taxed when surrendered before maturity and when kept till maturity.

Taxability of Traditional/Ulip plans

Traditional plans and unit linked plans (Ulips) are taxed in the same way. There would be three cases wherein taxation comes into consideration for these plans – Upon death of the insured, Surrendering the policy before maturity and Maturity proceeds of the policy.

Case 1: Upon death of the insured


policy proceeds received by the family members in the event of death of the policy holder is completely tax exempt under section 10 of income tax act. The family member needs to produce the death certificate to the insurer along with required proofs and directly claim the insurance amount.

Case 2: Surrendering the policy before maturity

If you surrender the policy before maturity, the taxability would depend on whether you have paid 5 premiums on the policy or not. If you have paid so, taxability would be nil. Else, the surrender value will be added to your total income for the year and taxed accordingly.

Case 3: Upon maturity

If you stay with the policy till maturity, the maturity proceeds are completely tax free.

Taxability of Pension plans

Pension plans are taxed in a completely different manner as compared to the traditional plans and ulips. There would be three cases of consideration when it comes to taxation of pension plans in India.

Case A: Death of Policyholder

The proceeds received by the family member upon death of the policy holder is completely tax free under section 10(10D).

Case B: Surrendering the policy before maturity

Surrendering the pension plan before maturity has serious tax implications. First of all, the premiums that you have claimed as part of deduction under section 80C will be reversed and you will have to pay tax on it. Secondly, the entire surrender value will be added to your income and you will have to pay tax on it according to your tax slab. According to latest rules of IRDA, 2/3rd of the surrender value received should be used to purchase annuity plan.

Case C: Upon maturity

The maturity proceeds under pension plans are tax free up to 1/3rd of the amount. Rest 2/3rd of the maturity amount needs to be used to purchase annuity plans as specified by IRDA.

Conclusion

So, these are the ways in which life insurance policies are taxed. Before purchasing any policy, do consider the taxation aspect as well. Do read the terms and conditions regarding taxability of life insurance policies as some of these policies could have greater tax implications. It’s better to avoid surprises in such cases.



Source: InvestmentYogi is one of the leading personal finance websites in India

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First Published: Fri, January 31 2014. 11:10 IST
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