Indian income tax laws provide for certain tax benefits in respect of premium paid on life insurance policies as well as for money received from insurance companies in respect of such insurance policies. Let us discuss these provisions.

Tax benefit in respect of premium paid for life insurance policies
As per Section 80C of the Income Tax Act, an Individual and a Hindu Undivided Family (HUF) are entitled to claim deduction up to Rs. 1.50 lakh on premium paid to buy and keep a life insurance policy active, along with other eligible items. For claiming this deduction, it is not necessary that the life insurance is bought from an Indian insurance company so even nonresident Indians or foreign nationals who have taxable income in India can claim this deduction even for a policy bought outside India.

This deduction is available in respect of all types of life insurance policies ranging from pure insurance product like term plans to insurance cum investment products like Unit Linked Insurance Plan (ULIP). This deduction is available in respect of premium paid for life insurance policies on the life of the assessee, spouse or any child even if financially independent. Please note that no benefit is available for premium paid for life insurance policies on the life of parents even if they are financially dependent on you. A HUF can claim deduction in respect of premium paid for policies taken on life of any member of the HUF.

The quantum of deduction available in respect of premium is restricted to 10% of the sum assured and any amount paid beyond 10% is to be disregarded for policies issued on or after 01-04-2012 except for life insurance policies on the life of physically handicapped person where a higher percentage of 15% is allowed. For the policies issued before 1st April 2012, a higher deduction of 20% is available. 

The life insurance policies in respect of which any tax benefit has been claimed have to be kept active for a minimum period of two years failing which the deductions allowed in earlier years is reversed and is to be added back to the income of the year in which the policy gets lapsed. 

The premium paid for buying an annuity plan whether immediate or deferred plan also enjoys tax benefits within the overall 80 C limit of Rs. 1.50 lakh.

Tax treatment of money received from an insurance company
Under Section 10(10D) of Income Tax Act, any money received from a life insurance company is tax-free provided the premium paid for any of the premium paying term year did not exceed 10% of the sum assured for the policies issued after 1st April 2012. For handicapped person, a higher percentage of 15% is to be considered for determining whether the money is tax-free or not.

In case the policy was issued between 1st April 2003 and 31st March 2012, the money would be tax-free in your hands if the premium paid during any year did not exceed 20% of the sum assured. Money received in respect of policies issued before 1st April 2003 are fully exempt irrespective of the quantum of premium paid. These exemptions are applicable for all the life insurance policies except keymen insurance policies and ULIP policies issued after 1st February 2021. Any money received on death of a person is fully tax free in the hands of the recipient except the amount payable under Keymen insurance Policies.

In case the insurance money received is taxable and the amount payable exceeds one lakh rupees, the insurance company will deduct tax at source @ 5% of the difference between premiums paid and the money payable.

However, your tax liability on such money received would depend on the slab rate applicable. Though there is no provision under the tax laws about the portion of insurance money received which would be taxable in your hands but in my opinion, only the difference between the money received and premiums paid should only be taxed as the tax deduction provisions also talk about the income component of the money being paid. Whether the difference would be taxed under the head “Income from other sources” or under the head “Capital gains” is debatable but in my opinion the premiums paid can be treated as investments and be taxed as long term capital gains or short term capital gains depending on the period for which the policy was alive and time difference between date of payment of premium and receipt of the insurance money with indexation benefit.

Money received in respect of ULIP policies issued after 1st February 2021, where the equity component has always been more than 65% in the fund, would be treated like equity-oriented schemes/listed shares and taxed under Section 112A at flat 10% beyond the initial exemption of one lakh rupees for long term capital gains earned along with long term capital gains on equity schemes and listed shares taken together.

The surrender value of annuity policies would be taxed fully if deduction was availed under Section 80CCC else the difference only may be taxed in your hands.

I am sure the above discussion would help you understand the nuances of tax laws for life insurance policies.

(The author is a tax and investment expert and can be reached on jainbalwant@gmail.com and @jainbalwant on Twitter.)

Balwant Jain is a guest contributor. Views expressed are personal.