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Is your life insurance maturity amount always tax-free?

Section 10 (10D) of the Income-tax Act decides whether the maturity proceeds of your life insurance policy will be tax-free or not.

September 20, 2022 / 08:17 AM IST

The answer will surprise you.

One of the most popular income-tax deduction benefits that most taxpayers use to the hilt and maximise each year is Section 80 C. Among the basket of instruments that offer section 80 C tax deduction benefits is insurance premium.

But there is another important section, Section 10(10D) of the Income-tax Act, which decides whether the maturity proceeds of your life insurance policy will be tax-free or not.

Yes, you read that right. The maturity payout of your life insurance policies may not always be tax-free as many people believe.

Also read: A year after Budget 2021, I-T department clarifies taxation rules of ULIP gains


How does Section 10(10)D determine taxation at maturity?

To make things simple, we are only talking here about traditional insurance schemes like endowment and money-back plans and also about ULIPs or unit-linked insurance plans. These are the only insurance-cum-investment plans that pay survival benefits on maturity. Put simply, we’re only talking of those insurance plans where you get your money back at the end of the policy’s tenure.

A pure term life insurance policy does not have any maturity or survival benefits and, hence, isn’t affected by the rule we are going to discuss.

Also, there is a difference between death benefits (paid out in the case of the death of the policyholder during the policy’s tenure) and maturity benefits (paid out on survival and completion of the policy term). And here, we are only talking about the taxation of maturity benefits. Death benefits are always tax-free.

That said, here is what Section 10(10)D is all about.

If you purchase a life insurance policy and the annual premium paid is more than 10 percent of the sum assured of the policy, the maturity proceeds (survival benefits) would be taxed.

This 10 percent rule is for policies purchased after April 2012. For those bought earlier, the rule threshold is 20 percent of the sum assured.

Let’s say you purchase an endowment plan with a sum assured of Rs 15 lakh. The annual premium you pay for this is Rs 1.8 lakh. Now as per the 10 percent rule to make maturity tax-free, the annual premium should be lower or equal to 10 percent of Rs 15 lakh, i.e., Rs 1.5 lakh.

But in this case, it’s Rs 1.8 lakh and more than the rule threshold. Since the 10 percent rule is not met in this case, the maturity payout from our policy will be taxable as per the tax rates that prevail in the year of maturity.

Generally, the maturity amount is made up of i) sum assured and ii) accrued bonuses over the years. So, this full maturity payout will be taxable if the annual premium is more than 10 percent of the sum assured.

Some people have doubts about whether it’s 10 percent of the sum assured or the maturity amount. The rule is very clear about it being 10 percent of the sum assured only. But there is a twist: you have to pay taxes on the entire maturity amount if the 10 percent rule is breached.

Also listen: Has COVID-19 changed the insurance sector forever?

ULIP Rs 2.5 lakh taxation rule vs section 10(10D)

Last year, the government attempted to rationalise the taxation of high-value ULIPs which were used frequently by HNIs or high net-worth individuals to avoid taxes.

Section 10(10D) allowing tax exemption of the maturity amount is still applicable to ULIPs as long as the annual premium is below 10 percent of the sum assured.

But Budget 2021 withdrew the tax-free status if the premium amount in the year exceeds Rs 2.5 lakh. For such policies, the gains on maturity shall be treated as capital gains and taxed under Section 112A. That is, the maturity proceeds of the ULIP will be taxed like mutual funds. Any capital gains made on such high-premium ULIPs will attract short-term capital gains (STCG) or long-term capital gains (LTCG) tax at redemption or maturity at par with other equity-oriented investments.

Keep investment and insurance separate

All this discussion about maturity payout taxation from life insurance should not make us push the idea of keeping investments and insurance separate to the backburner.

Term plans are the best option for life insurance. You don’t need any endowment or money-back plans or ULIPs for life insurance. You can instead invest in pure investment and savings products like the public provident fund, equity funds, etc.

Most people focus only on the tax-saving part (under section 80C) of their insurance premiums. But as we discussed in this article, it’s all the more important to ensure that you don’t purchase an insurance policy where you need to pay premiums that exceed 10 percent of the sum assured to avoid having your maturity amounts taxed.
Dev Ashish is a SEBI Registered Investment Advisor (RIA) and Founder, StableInvestor
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