The most obvious choice of individuals today are life insurance policies, that are advertised as providing tax breaks in the form of exemptions.
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With saving tax becoming the new mantra, most of us rush to pour our hard-earned
money into tax saving instruments in the hope that they’re exempt from the ever-
widening tax net. The most obvious choice of individuals today are life insurance
policies, that are advertised as providing tax breaks in the form of exemptions.
Tax benefits received through life insurance policies are specified under Section 80C of
the Income Tax Act.
This section details the tax benefits that life insurance policyholders stand to receive on
purchase of a life insurance product.
The purpose of providing tax benefits to policyholders was to encourage individuals to
save a portion of their incomes so they would have capital in the event of unforeseen
circumstances, and also provide a sum of money to dependents in case of the
policyholder’s untimely demise.
Most policy documents state that policyholders can claim tax deductions on their life
insurance policy premium amount.
However, this can be a little misleading as certain conditions have to be met for the
entire premium amount to be tax free.
Below, we’ve given you the 4 misconceptions regarding tax benefits on life insurance
● Entire premium amount is tax deductible- while this would be every
policyholder’s desire, tax benefit for life insurance policies is only applicable for
10% of the Sum Assured amount for policies purchased after April 2012. For
policies purchased before April 2012, policyholders will enjoy a tax deduction of
20% of their Sum Assured. With insurance companies offering premiums that are
less than 10% of the Sum Assured, tax breaks are negligible, to say the least.
● Tax benefits are irreversible- it is assumed that tax benefits availed are
permanent and irreversible. However, if the life insurance policy is surrendered
before the minimum holding period (5 years in case of ULIPs and 2 years for
other life insurance products), the tax benefits received are reversed. Thus, if an
individual buys a ULIP and surrenders it within 4 years of the purchase, any tax
breaks he received will be reversed and he will be taxed for the amount in the
year he surrenders the policy.
● Tax deductions are applicable to premiums for all family members- this is a
common misconception among life insurance policyholders. As per the
provisions of Section 80C, tax deductions can be enjoyed only in case of
premiums for the individual in question, his/her spouse and children. Deductions
cannot be claimed for insurance premiums paid for other relatives, such as
parents, siblings or in-laws.
● All insurance proceeds are exempt from tax- according to the Income Tax Act,
individuals are required to pay the applicable tax on all life insurance proceeds if
the premium paid is more than 10% of the Sum Assured. TDS (Tax Deducted at
Source) of 2% is deducted from insurance proceeds if the premium amount is
more than 10% of the Sum Assured for amounts above Rs.1 lakh. Beneficiaries
receiving insurance proceeds due to the death of the policyholder need not have
to worry though, as all proceeds received as a result of the demise of the
policyholder are exempt from this tax.
So the next time you’re looking for a way to save tax by investing in high premium
ULIPs and endowment plans, read the fine print carefully to ensure you’re receiving
the benefits without being short-changed on the insurance cover.