Life insurance is all about providing financial security for you and your family. Everybody has life objectives that require financial planning. By assisting you in creating a financial foundation while offering you the security of a life cover, insurance policies help you accomplish those goals.
Life insurance also has a significant impact on tax planning. According to the requirements of the Income Tax Act of 1961, by purchasing a life insurance plan, you are eligible to deduct certain expenses from your taxable income. This indicates that the insurance premiums you pay contribute to a cut in your tax obligations.
However, there’s a not so frequently asked question around this. Are the maturity benefits received from the insurance always tax free?
The idea that receiving the benefits from a life insurance policy is always tax-free is a fallacy or misconception that many individuals have. It is somewhat true, but not always, as the tax exemption is subject to specific requirements.
A life insurance policy's proceeds, including any bonuses paid at maturity or surrender, are subject to taxation under certain sections of the Income Tax Act.
Wait, let us explain.
In a normal conventional policy, the maturity amount consists of two parts: the sum assured and the cumulative bonuses accumulated over time.
The sum assured paid at the maturity or surrender of a policy, is entirely tax-free under Section 10(10D) of the Income Tax Act. The provisions of Section 10(10D) also apply to bonuses earned with the sum.
However, before utilizing the advantage provided by Section 10(10D), a crucial requirement must be satisfied: the premium to amount guaranteed ratio must fall within a predetermined range determined by the income tax department.
Any money received at the maturity of a life insurance policy or money received as a bonus is completely free from income tax under Section 10 for policies issued after 1 April 2012 if the premium paid on the policy does not exceed 10% of the sum guaranteed (10D).
Prior to 1 April 2012 (i.e., after 1.4.2003), it was 20% of the sum assured, implying that the sum assured had to be at least 20 times the premium.
For instance, the minimum sum assured must remain at Rs. 50 lakh if you pay a yearly premium of Rs. 5 lakh. To maintain the tax-free advantage at maturity, you must pay a minimum premium of 10 percent of the total insured is Rs. 50 lakh.
In the aforementioned example, one might pay a smaller premium, say ₹2.5 lakh, and still maintain a sum insured of ₹50 lakh, but anything beyond ₹5 lakh will result in the insurance losing its tax-free advantage.
Keep in mind that any proceeds received by the nominee upon the death of the policyholder are never subject to taxes and are not subject to the policyholder's tax liability. As a result, benefits received from a life insurance policy upon the death of the insured are always and unconditionally tax-free.