Depending on the time of pay-out the tax treatment changes.
Buying a pension plan from a life insurance company is a preferred choice for some individuals. The need for regular income makes some individuals opt for it. Though many financial planners may have expressed their reservations about pension plans, there are many who are curious about these plans. If you are one of those, spend some time understanding the taxation of these products.
Premium paid: Pension plans issued by life insurance companies expect the buyer to pay the premium. Premium paid up to Rs 1 lakh by the buyer are eligible for tax deduction under Section 80CCC of the Income Tax Act. This deduction falls within the overall limit of Rs 1.5 lakh under Section 80C of the Income Tax Act.
Commuted value: Some insurance companies allow you to take one third of the accumulated corpus as one time receipt instead of annuity, this is called commuted pension or commuted value. This sum is also exempt from tax. If one has not invested in other options such as EPF or PPF that allow him to get a large sum at one go, this provision is of great help. The remaining money however, must be used to purchase an annuity at going rate.
Surrender value: If you choose to surrender the pension plan, depending on the terms of the policy, the insurer computes the surrender value and pays the policyholder. “The surrender value is added to the income of the policyholder and offered to tax if he has availed of the tax benefits while paying premium. If he has not availed tax benefits, then the excess of surrender value over the premium paid, will be taxed at marginal rate of tax,” says Balwant Jain, a Mumbai based tax expert.
Death claim proceeds: Insurers offer a guaranteed death benefit or sum assured in case of the death of the policyholder during the currency of the policy. “This amount is tax-free in the hands of the nominee, irrespective of the amount or the tax slab of the nominee,” says Archit Gupta, CEO and founder of ClearTax.in
Annuity received: After the policy reaches vesting date, the insurer starts paying the pension to the policyholder. The regular income starts. This money – technically known as annuity - is added to the income of the policyholder and taxed accordingly.Please note that contrary to popular perception, all pensions are taxable in the hands of the receiver. If the policyholder has opted for joint life annuity, then the annuity received by one spouse after the death of the other is also taxable in the hands of the spouse.