Explaining the Tax Implications of Life Insurance Maturity Benefits
It may soon be time for your life insurance policy to mature after you have faithfully paid your premiums. All conventional life insurance policies, whether money-back or endowment plans have a maturity value that the policyholder will receive if they live out the policy’s term.
Additionally, if you bought the policy 15 or 20 years ago, there have been several tax-related changes since then. So, despite the many life insurance tax benefits, will you have to pay taxes on the maturity proceeds? Let’s first examine what will be included in the maturity proceeds.
Life insurance Maturity Amount
To keep things simple, we are discussing standard insurance schemes such as endowment and money-back plans and ULIPs or unit-linked insurance plans. These are the only insurance-cumulative-investment plans that pay out maturity benefits when they mature.
A pure term life insurance policy has no maturity or survival benefits and is thus unaffected by the rule we will explain.
There is also a distinction between death benefits (that are paid out to the nominee in the event of the policyholder’s death during the policy’s lifetime) and maturity benefits (paid out on survival and completion of the policy term). And we are only discussing the taxes of maturity advantages here. Death benefits are never taxed.
Tax Rules for Life Insurance Maturity Benefits
The sum assured paid upon the maturity or surrender of a policy or upon the policyholder’s death is entirely tax-free under Section 10(10D) of the Income Tax Act. A similar sum is also an exemption under Section 10 for bonuses received (10D).
Condition
Before utilizing the advantage provided by Section 10(10D), a crucial requirement must be satisfied: the premium to amount assured ratio must fall within a predetermined range determined by the income tax department. This ratio changed over time. Therefore, it will vary depending on whether you bought your policy before or after April 1, 2012.
Any cash received at the maturity of a life insurance policy or any amount received as a bonus is completely free from Income Tax under Section 10 for policies issued after April 1 2012, if the annual premium paid for the policy does not exceed 10% of the sum guaranteed (10D).
It was 20% of the sum assured for policies issued before April 1 2012 (after 1.4.2003), meaning that the premium could be a maximum of 20% of the sum assured.
Example
Assume you buy an endowment plan with a sum insured of Rs 15 lakh. This has an annual premium of Rs 1.8 lakh. According to the 10% rule, the annual premium should be less than or equal to 10% of Rs 15 lakh, i.e., Rs 1.5 lakh, for the maturity to be tax-free.
However, in this case, it is Rs 1.8 lakh, which exceeds the rule’s threshold. Therefore, because the 10% threshold was not met in this circumstance, the maturity payout from our policy will be taxed at the tax rates in effect at the time of maturity.
In general, the maturity amount consists of I the sum assured and ii) the earned bonuses over the years. As a result, if the annual premium exceeds 10% of the total insured, the complete maturity payout will be taxable.
Some people are unsure if it is 10% of the total assured or the maturity amount. The rule states unequivocally that it is limited to 10% of the sum assured. However, there is a catch: if the 10% rule is broken, you must pay taxes on the entire maturity amount.
ULIP Taxation Rule Vs Section 10(10D)
The taxation of high-value ULIPs, which HNIs or high-net-worth individuals widely utilized to evade taxes, was attempted to be rationalized by the government.
As long as the annual premium falls below 10% of the sum insured, Section 10(10D) tax exemption of the maturity amount is still applicable to ULIPs.
As a result, whereas standard insurance plans’ maturity proceeds, including bonuses and sum assured, are tax-free in the hands of the policyholder provided they meet the aforementioned requirements, there has recently been a tax adjustment for ULIPs. As a result, the return on the maturity of ULIPs issued on or after February 1, 2021, with an annual premium of Rs 2.5 lakh, would be recognized as a capital gain and levied in accordance with section 112A of the budget for 2021.
Most people only consider the portion of their insurance premiums that can be tax-deductible (under section 80C). However, as we covered in this article, it’s even more crucial to ensure you don’t buy an insurance policy where you pay premiums that are more than 10% of the sum assured and end up paying taxes on the returns.
