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Taxability on Life Insurance Pay-outs


Throughout your lifetime, you may have numerous financial goals. For achieving each goal, you would then need to perform the necessary calculations to develop financial strategies.

However, life itself is uncertain. Your untimely passing away can compromise these goals and leave your family high and dry. There is little one can do about life’s uncertainty except perhaps purchase life insurance plans. Besides offering financial protection, life insurance also provides tax benefits in regard to premium payments and pay-outs

Let’s understand what life insurance is and the taxability of the pay-outs it provides.

Understanding life insurance

When the only income-earning family member passes away, the dependents may be left without financial assistance. Here, life insurance can be of help. It lowers the monetary burden of such unforeseen events by providing a financial cushion such as death benefit payments. The insured’s dependents may get a lump-sum payment if something unforeseen were to happen to the insured.

Some life insurance policies offer the opportunity to receive a monthly income in addition to the lump sum death benefit. This monthly revenue may make it easier for the family to cover its usual expenses.

Many life insurance plans, especially endowment plans and ULIPs, also include maturity benefits. These are paid out if policyholders survive the term. Policyholders can then use the funds to achieve their life goals.

Consequently, pay-outs such as death benefits, maturity benefits, and bonuses, if any, can be beneficial financially.

Life insurance pay-out tax benefits

Life insurance tax benefits under the provision in section 10 (10D) provide that pay-outs made to policyholders or beneficiaries by insurance service providers are exempted from tax. Please note that tax benefits are subject to change as per prevailing laws.

The following section describes how death benefits and maturity benefits are exempt:

Death benefits: According to section 10 (10D) of the Income Tax Act of 1961, death benefits granted to the beneficiary upon the policyholder’s passing away are exempt from taxation.

Suppose, for instance; the significant household breadwinner passes away. And suppose they held a valid life insurance policy. So, the policyholder’s spouse, the beneficiary, receives the money insured. According to section 10(10D) of the Income Tax Act of 1961, this amount is exempt from taxation in the spouse’s possession.

Maturity benefits: If you ask, what is life insurance with maturity benefits, then here is the explanation. A pure life insurance provides just death benefits. However, many other life insurance policies offer maturity pay-outs, which are paid at the end of the policy’s term. These rewards may also contain additional or terminal bonuses.

Section 10(10D) of the Income Tax Act of 1961 exempts maturity payments from taxation, subject to the following conditions:

  • The yearly premium for life insurance contracts issued on or after 01.04.2003 but before 31.03.2012 can be at most 20% of the sum assured.
  • The yearly premium for life insurance plans issued on or after April 1, 2012, should be at most 10% of the sum assured.

When are life insurance pay-outs subject to taxation?

There are a few circumstances in which life insurance pay-outs may be taxed. Herein are the specifics.

Scenario 1: If there is interest in cumulative death benefits:

Occasionally, policyholders would specify that the death benefit should not be paid immediately upon their passing. In such instances, the insurer retains the death benefits for the duration stated. During this period, interest accrues on the sum assured. And when the benefits are ultimately paid out to the beneficiaries, only the interest received would be taxable.

Scenario 2: If the pay-outs become part of the policyholder’s estate:

In certain instances, the beneficiary may pass away before the policyholder. Eventually, following the policyholder’s demise, the death benefits would become part of the deceased’s estate. This is because there is no nominee to whom the insurance provider can pay the death benefit. When this happens, the proceeds are taxed like the rest of the estate and inheritance.

This can be rare in India, as insurance providers insist on primary and secondary nominees.

In addition to the pay-out being tax-free for the nominee, the policyholders can also avail of life insurance tax benefits during their lifetime as the premiums paid by the insured are allowed for deduction per the Income Tax Act.

Note: Many life insurance tax benefits are only applicable to taxpayers under the old tax regime. The new tax regime does not permit multiple tax benefits.

Thus, one of the most significant benefits of buying life insurance and securing your family financially is the tax benefits that one can take advantage of.

Insurance is the subject matter of solicitation. For more details on benefits, exclusions, limitations, terms, and conditions, please read the sales brochure/policy wording carefully before concluding a sale.’

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