Insurance & Indian Income Tax

Life insurance is the least understood of all financial products. While the basic purpose of insurance is to protect the dependents of the insured from financial distress in the event of his/her death, it is usually bought as a tax saving tool or an investment option.

People often confuse investment and insurance and I had elaborated about the same in my article on Insurance. To read more Click Here

This article is about the conditions that need to be considered before taking an insurance policy for tax saving.

All of us know that insurance policies give us tax exemption under sec 80C of the Indian Tax laws but not all policies or rather not the entire amount of insurance premium is exempt from income tax.

Income tax comes into play at 2 points during the term of your insurance policy.

1. At the time of buying the policy (The tax benefits on the premium paid)
2. When you receive the policy proceeds at the end of the policy term

You may be wondering by now, I know that my entire premium is eligible for tax deduction as long as it is less than 1 lac. Well thats not the case. There is a catch here which not many of us know.

The deduction is allowed only if the premium is less than 20% of the insurance cover. For example if you take a policy for Rs. 1,00,000/- and your premium is Rs. 30,000/- per annum then only Rs. 20,000/- is eligible for tax purposes. The tax deduction also requires you to be bound to the policy for atleast 3 years to get the tax benefit. If you terminate your policy within 3 years, the tax deduction that you availed is withdrawn and that amount would be a taxable income and you would have to pay tax on it.

There are other tax rules that you should be aware of, especially if you take a single premium plan. If the insurance is terminated within 2 years in case of a single premium policy, the tax deduction allowed earlier is taxable as income.

Lastly, there is some good news for all of us. Any sum received by a policyholder (You) on maturity is totally tax free. (for normal insurance policies)

If you have a pension plan and are receiving your maturity amount, only 33% of the total corpus is tax free. The balance is taxable and you need to pay tax on the same that year.