Life insurance is a good way of dealing with uncertainties in life and securing the financial future of your loved ones. It ensures that when the policyholder passes away, his family members and dependents do not have to suffer for lack of money. This is made possible by the payment of the death benefits. Some insurance plans, like Unit Linked Insurance Plans or ULIPs or endowment plans or money-back plans, also include payment of maturity benefits if the policyholders survive the policy term. These benefits are used to fund the various life goals, like funding a child’s education or marriage or retirement or any other goals of the policyholder. The premium and the term for these policies can be decided with the help of a life insurance premium calculator. How are these benefit payments treated? Are they taxable? Let us find out the answers to these questions.
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Who are Beneficiaries?
Anyone buying a life insurance policy has to specify the name of a nominee or a beneficiary who will be entitled to receive the death benefit upon the death of the policyholder. A beneficiary is generally a family member of the policyholder and can be the parent, the spouse, or the child.
Tax Treatment of Insurance Policy Pay-outs
As per Section 10D of The Income Tax Act, 1961, any income received from a life insurance policy is exempt from income tax. This includes the sum assured, the accrued bonus, and the returns from a ULIP. These exemptions can be claimed by individuals- both salaried and non-salaried, Hindu Undivided Families or HUFs, Associations, Trusts, Companies, Body of Persons, and even Foreign Companies.
- Death Benefits– The death benefits paid out by an insurance company to the beneficiary of a policy upon the death of the policyholder are completely tax-free.
- Maturity Benefits– Many types of life insurance policies include maturity pay-outs on the completion of the policy term. These pay-outs can include bonuses too. Section 10D allows exemption of such pay-outs from tax, subject to certain conditions wherein for policies issued before 1st April 2012, the annual premium does not exceed 10% of the sum assured and for policies issued after 1st April 2012, the annual premium does not exceed 10% of the sum assured. In case the policyholder is severely disabled or suffering from specific diseases, the exemption is available on policies issued before 1st April 2013 if the annual premium does not exceed 15% of the assured sum.
Instances When Beneficiaries Have to Pay Tax
- Interest on Accumulated Death Benefits– In cases where the policyholders seek the payment of death benefits after a specified period (and not instantly) and the sum assured earns interest. In such a situation, when the pay-out is paid after some time, the interest portion is taxable, while the original pay-out amount remains exempt from any kind of tax.
- Pay-out Becomes Part of the Policyholder’s Estate– In situations where the beneficiary of a policy passes away before the policyholder, the death benefits become part of the policyholder’s estate after his death. This situation occurs due to the absence of a nominee who can be paid the death benefits. In such a scenario, the proceeds are taxed like the rest of the estate and inheritance. However, such situations are rare, as most insurance companies ask policyholders to specify a primary as well as a contingent beneficiary.
Tax Deducted at Source
Since October 2014, if the amount received from a life cover policy is more than Rs 1,00,000 on policies that are not eligible for exemption under Section 10D, a TDS of 1% is deducted by the insurance company before making the payment. This deduction is applicable to bonus payments also. If the amount received from the insurance company is less than Rs 1,00,000, no TDS is deductible.
Taxation in Maturity Amount of Single-Premium Policies
The maturity amount of a single premium insurance policy is taxable and not exempted under Section 10D of the Income Tax Act, 1961. A taxation benefit is available if the minimum sum assured is ten times the single premium amount paid for the policy.
Capital Gains Tax on Returns from ULIPs
Budget 2021 introduced a new tax on gains made in ULIPs issued on or after 1st February 2021. The returns on the maturity of ULIPs whose annual premium is Rs 2.5 lakh or more shall be treated as capital gains, the budget mentioned.
To conclude, a death benefit received from a life insurance policy is always non-taxable, but the rules vary for maturity benefits. Beneficiaries need to check whether the concerned policy falls under the exclusions of Section 10D or not. It is better to check the rules relating to ULIPs, single premium policies, and policies where the premium outgo is quite high.