The primary purpose to buy life insurance is to financially equip yourself and your family against the worst in life. Depending on the type of life insurance policy, you receive a death benefit, survival benefit, and even an opportunity to save for life goals. The benefits of life insurance are many and these can further be strengthened by adding riders to your life insurance such as a critical illness rider. There’s another aspect to consider when you buy life insurance and that is tax-saving.
Life insurance policies offer several tax benefits under different sections of the Income Tax Act, 1961. While saving tax should not be the primary purpose for which you buy life insurance, it’s prudent to optimise on the available tax benefits when you do have a life insurance policy in place.
What types of life insurance policies offer tax saving benefits?
In India, there are several kinds of life insurance plans you can buy according to your financial goals and life stage. Here are the popular kinds of life insurance plans:
- Endowment plans
- Term life insurance
- Unit-linked insurance plan (ULIP)
- Whole life insurance
Before we get into the tax benefits, it’s essential to note that currently there exist two tax regimes and as a taxpayer you can pick the one that most benefits you. Under the old tax regime, the income slab rates are slightly higher than the new regime, however tax benefits are available. Under the new tax regime, tax slab rates are comparatively lower, but you need to forego the tax exemptions and deductions.
Tax deductions on life insurance policies
You must have heard of one section of the income tax act being quoted by people around you many times. That is the popular section 80C. Most of the insurance tax benefits offered fall under this section. Let’s break it down for you.
- You can claim a tax deduction of up to Rs 1.5 lakh in a financial year.
- This is applicable for individuals as well as Hindu Undivided Families (HUFs).
- The deduction is for the premium paid on your life insurance policy.
- Before you buy life insurance, you can use an online life insurance premium calculator to figure out how much premium you’ll be paying on your policy.
- You can claim the deduction for the premium you pay for life insurance policies for yourself, your spouse and your children.
- This limit of Rs 1.5 lakh can be claimed for various investments. So even if your life insurance premium doesn’t add up to Rs 1.5 lakh in a given year, you can claim the remaining amount for investments such as pension funds like NPS or investments like ELSS funds.
- For life insurance policies issued before 31st March 2012, the maximum premium deduction that can be claimed is up to 20% of the sum assured.
- This limit has been changed from 20% to 10% for life insurance policies issued on or after 1st April, 2012.
- If the policyholder suffers from an illness or disability as specified by the income tax act rules under section 80U or 80DDB, such as autism, blindness etc., the limit of 10% on life insurance premium can be increased to 15% even if the policy has been issued on or after 1st April 2012.
- An important condition to note is that if you cancel your life insurance policy, either by choice or it is terminated due to non-payment of premiums, within two years from the commencement of the policy, the tax benefits you claimed under section 80C will be reversed. However, such a lock-in period is five years for ULIPs.
Tax exemptions on life insurance policies
At the time of receiving the life insurance policy proceeds, including bonus, in either of the following cases:
- Maturity of the policy
- Claim in event of death of the policyholder
- Surrender value of the policy in case of cancellation by policyholder
The proceed or sum assured will not be subject to taxation under section 80D(10D) of the income tax act. However, there are a few conditions under which the life insurance policy proceeds will be taxable:
- In case it’s a group life insurance policy offered by an employer.
- Keyman life insurance policies (a type of business insurance where the proposer and premium payer of the policy are the same person).
- Life insurance policies where the premium paid in any one year exceeds 20% of the sum assured for policies bought on or before 31st March 2012 and 10% for policies bought on or after 1st April 2012. The limit is 15% for policyholders with a disability or disease as specified under section 80U and 80DDB.
- The maximum limit highlighted above is not applicable for pay outs received as a death benefit. For death claims, even if the life insurance premium paid exceed the prescribed percentages, the nominees would not be taxed on the sum assured received.
When you buy life insurance, you get the opportunity to save big on taxes. And that is only the secondary benefit of a life insurance policy. Hence, by including a life insurance policy in your investment portfolio, you can enjoy the dual benefits of life cover and tax-saving.