What you need to know about the taxation of life insurance policy payments

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By Suraj Goel

This is the second article in a two-part series on tax benefits and other tax aspects of life insurance Strategies. This article discusses the tax treatment of the proceeds of these policies. The first in this series focused on the tax benefit available under Section 80C of the Income Tax Act, for premiums paid for life insurance policies. Click on here to read the first article.

The general impression among people is that proceeds from life insurance policies are completely tax exempt. However, this is actually subject to certain conditions and also certain exceptions. It is necessary to know when this income is tax exempt and when it is not, in order to take advantage of the tax advantage. Let’s take a closer look at the tax treatment of payouts under a life insurance policy.

Pension policies, some of which include an element of life insurance, are treated differently for tax purposes. Therefore, these have not been covered here.

Section 10(10)D Income Tax Act 1961

In accordance with Section 10 (10D) of the Income Tax Act 1961, the amount of the sum assured plus any bonus (i.e. policy proceeds) paid at maturity or on the surrender of the policy or on the death of the insured is entirely tax-free for the recipient subject to certain conditions.

This policy proceeds will be taxable in the hands of the insured in the following situations:

oh
In accordance with Article 10(10D) in the case of a life insurance policy issued after 1.4.2003 but no later than 31.3.2012, if the premium payable in a year exceeds 20% of the actual sum insured, the proceeds of the policy would then be taxable in the hands of the insured. In accordance with Section 10 (10D) read with an explanation in Section 80C (3A), the actual sum insured simply means the sum insured which is the lowest of all policy years and does not include any bonus amounts which must be received in addition to the insured amount. This “actual sum insured” will also not include the premiums which must be returned to the policyholder.

oh For policies issued on or after 1.4.2012, the 20% limit mentioned above has been changed to 10%.

In the event that the insured suffers from a severe disability or illness as specified by law and income tax rules and his policy was issued on or after 1.4.2013, the limit 10% will be increased to 15%. For this purpose, the disability must be one of those specified in section 80U (such as autism, mental retardation) and the disease must be one of those specified in section 80DDB read with rule 11DD of the income tax rules such as blindness.

oh In the event that the premium payable in any year exceeds the prescribed percentage, i.e. 10%, 15% or 20% of the actual sum insured, as described in the preceding paragraphs, the entire Policy proceeds would be taxed the year it is received. However, in the event of the death of the insured, when his agents receive the proceeds of the policy, the proceeds will be tax-free in the hands of the agent or agents, even if the premium paid during a year exceeds the prescribed percentage of the sum insured.

Keyman insurance policy proceeds are not tax exempt

If a policy is a Keyman insurance policy, its proceeds are not exempt from tax under Section 10(10D) of the Income Tax Act.

Does TDS apply to the payment of proceeds from a life insurance policy?

Pursuant to Section 194DA of the Income Tax Act 1961, any sum received by an insured Indian resident from an insurer under a life insurance policy is subject to TDS @ 2% if such sum is not exempt under section 10 (10D). This means that policy proceeds exempted under Section 10 (10D) will be returned to the insured without TDS (Tax Deduction at Source). Moreover, even if these products are taxable according to Article 10 (10D) but do not exceed Rs 100,000, then no TDS should be deducted by the insurer when paying the insured.

It is important that you know that you must submit your PAN to your insurer otherwise the TDS rate would be 20% instead of 2% in cases where the TDS is applicable.

Furthermore, it should be mentioned that the tax treatment of life insurance policies taken out with foreign insurers (those not registered in India) may involve additional conditions which vary from case to case.

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