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Are Life Insurance Payouts Taxable? 

Life insurance is a safety shield for you and your loved ones as it provides financial support in bad times. But there is always a question in the mind of policyholders: are life insurance payouts taxed? Let’s explore this in this blog today. 

Taxability of life insurance payouts 

Few life insurance plans, such as endowment plans and ULIPs, offer maturity benefits and are paid to the policyholders if they survive the policy terms. Life insurance payouts are typically exempted from taxes as they have many tax benefits under the Income Tax Act 1961. Section 80C and 10 (10D) of the Income Tax Act offer these tax benefits. When you understand what is life insurance, knowing about their taxation is also crucial.

Benefit Under Section 80C

Insurance premiums paid for your life insurance or spouse or children are eligible for tax deduction under Section 80C of the Income Tax Act. Whether your child is dependent or independent, minor or major, married or unmarried, the tax deduction benefits are applicable for premium payouts. 

You can claim up to Rs. 1.5 lakh every year. It applies to all the policies from any insurance provider and is approved by the Insurance Regulatory and Development Authority of India (IRDAI). 

This deduction applies to all eligible finance products such as PPF, NSC, ELSS, fixed deposits, home loan repayment, tuition fees, etc. However, you must remember that the premium paid for the life insurance policy should not exceed 10% of the sum assured. This rule has been applicable since 1st April 2012; before that, the limit was 20% of the sum assured. 

Benefit Under Section 80 D

Under this section of the Income Tax Act 1961, individuals and HUFs are eligible for a tax benefit on insurance payout of up to Rs. 25,000. Also, you can avail of a deduction of Rs. 50,000 for a senior citizen’s health insurance if you have purchased life insurance for your dependent parents. 

Benefit Under Section 10 (10D)

Tax benefits can also be availed on the amount received from the insurance policy as the death benefit under Section 10 (10D), apart from the tax deduction. In this case, the nominee of the policyholder can get the entire amount without paying any taxes on the amount received, and there is no maximum limit to the tax exemption under Section 10 (10D). 

Tax Breakdown of Life Insurance Plans

Life insurance has different scenarios where an insured receives money from the insurance company; let’s understand how they are taxed:

Premiums Paid

You can avail tax benefits on the premium you pay for the life insurance under Section 80C of the Income Tax Act up to Rs. 1.5 lakhs annually. The policyholder can claim this deduction for the premiums paid for their spouse’s or children’s policy. 

Death Benefits

When the nominee receives the death benefit on the insured person’s death, the amount received is also eligible for tax benefits under Section 10 (10D) of the Income Tax Act. 

Maturity Benefits

Typically, the amount received from the maturity of the insurance policy is exempted from taxes under Section 10 (10D) of the Income Tax Act. The entire amount is tax-exempt when the nominee gets the maturity amount when the policy matures. 

Riders 

Every rider, such as critical illness, accident rider, etc. may attract different tax implications. So, while buying the policy, you must understand the taxation of every rider you use. 

Surrender Value

Surrendering a life insurance policy refers to ending the actual tenure of the procedure and redeeming it before maturity. The tax rules on surrendering your life insurance policy depend on the type of policy you purchased, and tax exemption on surrendering the life insurance policy is applicable only in a few cases:

  1. If you have purchased a traditional life insurance policy, such as an endowment plan. Then in such a case, the surrender value remains tax-free, but one should have paid the premiums regularly for the first two years of the policy tenure. 
  2. The surrender value remains tax-free if you purchase a single premium life insurance policy. However, you must hold the policy for the first two years after purchasing. 
  3. In the case of ULIP, the surrender value is tax-free if you surrender the policy after five years from the date of purchase. 

Remember to utilise a life insurance calculator to take full advantage of tax benefits available to you.

TDS on Life Insurance Policy 

Suppose the amount received under a life insurance policy exceeds Rs. 1 lakh and is not covered for tax deduction under Section 10 (10D); in that case, TDS at 1% shall be deducted by the insurance company before making the payment. TDS will also be deducted from bonus payments. And if the amount received is less than Rs. 1 lakh, no TDS will be deducted, but the amount will be taxable for the policyholder. 

Conclusion 

The tax implication of life insurance policies may seem like a daunting task. However, you should focus on understanding the terms and benefits of each life insurance policy while purchasing the plan. As we have seen, most life insurance policy payouts are tax exempted, but there are few rules if you surrender it before maturity. You can also use a life insurance calculator to understand the numbers of your insurance policy better. Stay informed and maximise the benefits of your coverage. 

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