A Detailed Report on the Taxability of Life Insurance Policies in India

1. Investment: Tax Benefits on Premiums Paid (Section 80C)

The primary tax advantage for LIP holders comes at the investment stage. Premiums paid towards a life insurance policy for oneself, spouse, or children qualify for a deduction from taxable income under Section 80C of the Income Tax Act, 1961.

• Deduction Limit: The maximum deduction that can be claimed under this section is capped at ₹1.5 lakh per financial year. This limit is inclusive of other eligible investments and expenditures under Section 80C, such as contributions to the Public Provident Fund (PPF), Employees' Provident Fund (EPF), and National Savings Certificates (NSC).

• Conditions for Claiming Deduction:

  • The premium paid in a financial year should not exceed 10% of the actual capital sum assured for policies issued on or after April 1, 2012.

  • For policies issued between April 1, 2003, and March 31, 2012, the premium should not exceed 20% of the sum assured.

  • In the case of a policy taken for a person with a severe disability (as per Section 80U) or suffering from a specified disease (as per Section 80DDB), the premium limit is extended to 15% of the sum assured for policies issued on or after April 1, 2013.

2. Bonus: Tax Treatment of Accrued Benefits

Life insurance policies, particularly participating or 'with-profit' plans, accrue various bonuses over the policy term. These include:

• Revisionary Bonus: Declared annually and added to the policy account.

• Terminal Bonus (or Loyalty Bonus): A one-time bonus paid at the time of maturity or death claim, rewarding long-term policyholders.

The tax treatment of these bonuses is not separate from the main policy proceeds. They are considered part of the "sum received" under the life insurance policy. Therefore, the taxability of bonuses is intrinsically linked to the taxability of the maturity or surrender proceeds under Section 10(10D) of the Income Tax Act. If the maturity proceeds are exempt from tax, the accrued bonuses will also be exempt. Conversely, if the maturity proceeds are taxable, the bonus component will also be subject to tax.

3. Maturity Proceeds: Navigating Section 10(10D) and its Amendments

The taxability of the lump sum amount received upon the maturity of a life insurance policy is governed by Section 10(10D) of the Income Tax Act. This section provides for the exemption of such proceeds, subject to certain conditions.

Conditions for Tax Exemption under Section 10(10D):

The exemption on maturity proceeds is contingent on the premium paid in any of the years during the policy term not exceeding a certain percentage of the sum assured. The slabs are as follows:

• For policies issued before April 1, 2012: The premium paid should not exceed 20% of the sum assured.

• For policies issued on or after April 1, 2012: The premium paid should not exceed 10% of the sum assured.

• For policies issued on or after April 1, 2013, for the life of a person with a disability or specified ailment: The premium paid should not exceed 15% of the sum assured.

The Impact of the Finance Act, 2023:

The Finance Act, 2023, introduced a significant amendment to Section 10(10D) to tax high-value non-ULIP life insurance policies.

• For policies issued on or after April 1, 2023: The maturity proceeds (including any bonus) will be taxable if the aggregate of the annual premiums payable for one or more life insurance policies (other than ULIPs) exceeds ₹5 lakh in any of the previous years during the term of the policy.

The income from such taxable maturity proceeds will be taxed under the head "Income from Other Sources" at the applicable slab rates.

Tax Deducted at Source (TDS) on Maturity Proceeds (Section 194DA):

If the maturity proceeds of a life insurance policy are taxable (i.e., they do not meet the conditions for exemption under Section 10(10D)), the insurance company is required to deduct tax at source (TDS) under Section 194DA of the Income Tax Act.

• TDS Rate: TDS is deducted at the rate of 5% on the income component of the payout (i.e., maturity proceeds minus the total premiums paid).

• Threshold: TDS is applicable only if the aggregate amount of such proceeds paid in a financial year to a policyholder is ₹1 lakh or more.

• No PAN: In the absence of a Permanent Account Number (PAN), the TDS rate will be 20%.

4. Death Claim: A Tax-Free Haven for Beneficiaries

One of the most significant and unwavering tax benefits of life insurance is the tax treatment of the death claim.

• Complete Tax Exemption: The entire sum of money received by the nominee or the legal heir of the deceased policyholder as a death benefit is fully exempt from income tax under Section 10(10D).

This exemption holds true irrespective of the premium paid in relation to the sum assured and is not affected by the amendments introduced in the Finance Act, 2023, for high-premium policies. This ensures that the financial support intended for the family in the event of the policyholder's demise is not diminished by tax liabilities.

Summary of Taxability of LIP in India:

In conclusion, while life insurance remains a valuable tool for financial security and tax planning, it is imperative for policyholders to understand the nuances of its taxability. The recent changes emphasize the need for careful consideration of the premium-to-sum-assured ratio and the aggregate premium outgo for policies purchased in the current financial landscape to avoid unexpected tax liabilities at the time of maturity. The death benefit, however, continues to be a completely tax-free proposition, reinforcing the primary objective of life insurance as a tool for family protection.