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Are You Getting Tax Benefits from Your Life Insurance?

Many people consider life insurance plans to be excellent tax-saving instruments. But sometimes, you may not get the expected tax benefits on such policies. We highlight all you need to know about life insurance and its tax implications.

Life insurance is a financial instrument that you can use for bequest planning to leave behind a legacy for your family. But while leaving a legacy is important, there is also a potential tax burden that you will want to address—this is where life insurance can help.

Despite the tax benefits you can enjoy on life insurance, the government has made certain conditions and also some exceptions that you should take into account when choosing a life insurance policy. It’s these provisions that determine whether and how much of your life insurance premiums and proceeds qualify for tax exemptions. Here, we’ve broadly highlighted relevant tax treatment of premiums and payouts under a life insurance policy.

Tax Benefits on Life Insurance Premiums

You may be aware that life insurance premium up to a maximum of Rs. 1.5 lakh per financial year is eligible for tax deduction under Section 80C1 of the Income Tax Act, 1961. But this deduction is available only on the premium paid by you in every financial year for life insurance purchased for yourself, your spouse and children. Also, to continue getting a tax benefit, you need to hold the policy and pay the premiums for a certain time frame as specified under Section 80C.

Let’s talk about the maximum premium that you can claim as deduction from your total income under Section 80C*. If your life insurance policy was issued on or after April 1, 2003 but on or before 31st March 2012, the annual premium up to a maximum limit of 20% of the actual capital sum assured (excluding any bonus) is allowed as a deduction from your total income.

For life insurance policies that were issued on or after 1st April 2012, limit of 20% was reduced to 10%. But in case of life insurance bought by an individual suffering from disability or certain diseases (as specified under the Income Tax Act, 1961 and the Rules framed thereunder) and issued on or after 1st April 2013, the limit is enhanced by 5%, which translates to 15% of the actual capital sum assured.

Taxation on Life Insurance Proceeds

The amount received by a nominee as death benefit qualifies for tax exemption under section 10 (10D) of the Income Tax Act, 1961. This bodes well for the proceeds your beneficiaries would receive in case you are no more.

But did you know that the life insurance payouts received on maturity (not in case of death) are not always tax-free? The maturity proceeds of an insurance policy are taxable as per slab rates of the individual if the yearly premium during the policy term is more than the criteria regarding the actual capital sum assured stated in paragraph 4 and 5 above. For life insurance policies which are not exempt under section 10 (10D) of the Income Tax Act, 1961, with a maturity value of more than Rs. 1 lakh, the insurer needs to deduct tax at source at 1% on the entire payout amount.

The bottom line

While tax benefits on premiums and proceeds can be an additional advantage of life insurance, it’s important to understand that it’s not the primary objective of this type of policy. Life insurance is principally a medium to financially protect your dependents if you are no more. Therefore, in order to make the right tax-planning decision, you need to first understand the ins and outs of a policy.

Companies such as HDFC Life offer insurance plans in different categories such as protection, investment, health and retirement that can help you save taxes. For instance, HDFC Life’s life insurance and unit-linked insurance plans (ULIPs) can help you save as much as Rs. 46,350 on tax yearly under Section 80C1, while their health insurance plans offer tax benefits of up to Rs. 16,955 under Section 80D2 annually. Confused about which insurance plan is best for your tax-saving and financial protection needs? HDFC life also gives you professional guidance in this regard.

Disclaimers

1. Section 80C

- Maximum investment allowed as per Section 80C of the Income Tax Act, 1961 = Rs.1,50,000. Tax @ 30% (highest tax rate applicable to a salaried individual) on Rs.1,50,000 = Rs.45,000. Education Cess @ 3% on tax of Rs.45,000 = Rs. 1,350. Hence total tax saved = Rs.45,000+ Rs.1,350 = Rs.46,350.

2. Section 80D

- Maximum investment allowed as per Section 80D of the Income Tax Act, 1961 is:

a. Rs.25,000 /- for self, spouse and dependent children and

b. Rs.30,000/- for parents who are senior citizens (with age being 60 years or more)

i.e. Total deduction can be claimed under Section 80D is Rs.55,000. Tax @ 30% (highest tax rate applicable to a salaried individual) on Rs.55,000 = Rs.16,500. Education Cess @ 3% on tax of Rs.16,500 = Rs.495. Hence total tax saved = Rs.16,500 + Rs.495 = Rs.16,995.

3. The aforesaid stated views are based on the current Income Tax law. Also, you are requested to seek tax advice from your chartered accountant or personal tax advisor with respect to your personal tax liabilities under the Income Tax law.

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