Income Tax Rules on Life Insurance Policies for Indians

Financial planning often involves choosing life insurance as part of the strategy. An insurance policy is primarily designed to provide financial assistance to your family in the event of your untimely death, but it can also be used to accumulate wealth over time. How does the sum assure that the policyholder receives on maturity or following his or her death be taxed? The following are a few things we need to know:

The Income Tax Act of 1961, Section 10(10D), mandates that all death benefits are tax-free. However, maturity benefits are taxed according to premiums paid.

Traditional policies calculate maturity amounts as the sum assured plus the bonuses accrued during the policy period (in a with-profit plan). Thus, all annual bonuses declared on the amount in these years should be separated from the sum assured.

Upon maturity, the sum assured amount is fully tax-exemption according to Section 10(10D). In addition, this section also exempts bonuses received in conjunction with the sum assured.

It is important to keep in mind, however, that after April 01, 2012, you will be tax-exempt on policies only if you do not pay more than 10% of the policy sum insured. As long as the total premiums don't exceed 20 per cent of the sum assured if the policies were issued before April 1, 2012, the sum assured will not be taxed.

There are similar conditions that must be met by life insurance policies in order to qualify for tax relief under Section 80C.

There are stark differences between the tax consequences of unit-linked insurance plans (ULIPs). In accordance with the income tax regulations announced under the Budget, for ULIPs with annual premiums up to INR 2.5 lakh allocated on or after February 1, 2021, the return on maturity would be treated as capital gains and taxed under Section 112A.

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