It is the time of the year when you are rushing to fill your tax deduction limit under section 80C. You are being approached by a number of insurance agents. You are confused about which product to buy. Don’t worry you are not alone. Most of us go through a similar situation. We do not plan anything during the entire year. When the end of the financial year approaches, we feel prey to the best sales pitch without considering the pros and cons of the product.
A number of us take the refuge of life insurance policies towards the end of financial year to save taxes. Most insurance plans (especially those marketed as an investment product) have a high cost structure and provide sub-optimal returns. We have covered this aspect of investment cum insurance products in an earlier post. In this post, we want to highlight a different aspect that many such insurance plans may not even save you tax. A common perception is that your entire insurance premium is tax deductible. However, this is not the case. The quantum of insurance premium which can be claimed for tax deduction is restricted in relation to the Sum Assured. In this post, we discuss such restrictions and the impact if such restrictions are not adhered to.
Which life insurance premium is tax deductible?
Any amount paid towards life insurance premium for yourself, your spouse and children qualify for deduction under Section 80C. However, premium paid by you for parents/siblings/in-laws is not eligible.
How much life insurance premium is tax deductible?
Not all life insurance premium paid is tax deductible. If the policy is issued on or before March 31, 2012, annual premium up to a maximum of 20% of the Sum Assured is tax deductible. In case the policy is issued on or after April 1, 2012, annual premium up to a maximum of 10% of Sum Assured is tax deductible. An additional relaxation of 5% (i.e. up to 15% of Sum Assured) is available to person suffering from disability or sever disability (as specified under Section 80 U) or to those suffering from a disease or ailment as specified under Section 80DDB. For a life insurance policy, Sum Assured is the minimum amount assured to the nominee (of the policyholder) in the event of death of the policy holder.
Let’s consider an example. If you purchase an insurance policy with a sum assured of Rs 4,00,000 and an annual premium of Rs 50,000, only Rs 40,000 (10% of Sum Assured) is tax deductible. You won’t get any tax benefits for the balance premium. Any premium in excess of the aforesaid limit (10% of Sum Assured for the new policies) shall not qualify for tax deduction under section 80C of the Income Tax Act. Please note tax deduction is subject to an overall ceiling of Rs 1,50,000 under Section 80C.
Taxation of Insurance Proceeds
Any proceeds from the insurance policy resulting from the death of the policyholder are tax free. Please note that the proceeds from the insurance policies (other than in case of death) that do not meet the aforementioned criteria (percentage of sum assured) are taxable at the time of maturity. Hence, for any new policy purchase where annual premium exceeds 10% of the sum assured, the insurance proceeds (other than in case of death) will be taxable.
A financial product’s tax structure is one of the critical elements that are considered before purchase of a financial product. However, you must never purchase a financial product just to save taxes. For instance, loading up on 5 year fixed deposits year after year just to save taxes is not going to help you meet your long term goals. The product should fit in to your overall financial planning. If such a product helps you save taxes, that is an additional positive.
We advise to keep your insurance and investment needs separate. If you buy a pure term insurance plan, these restrictions are unlikely to be a problem as the Sum Assured is a very high multiple of premium paid. A Sum Assured of Rs 1 crore will have an annual premium in the range of Rs 6,000-12,000 for a 30 year old. It is when you mix your investment and insurance needs that these restrictions can come into play.
However, if you have decided to purchase an insurance plan, do keep this taxation aspect in mind. Don’t go just by the words of the insurance agent. If you purchase an insurance policy that exceeds 10% of the Sum Assured, only a part of your insurance premium will be tax deductible. Not only that, the proceeds from such an insurance policy will be taxable at the time of maturity.
Deepesh is Founder, PersonalFinancePlan.in