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Do Beneficiaries Pay Taxes on Life Insurance?

Beneficiaries do not pay taxes on life insurance returns. However, there are specific situations that may lead to potential tax implications on beneficiaries as well.

  • 20,984 Views | Updated on: Mar 12, 2024

Life insurance offers death benefits to the beneficiaries of the policy. These benefits are usually exempted from income tax. When the beneficiaries avail death benefits received from a life insurance policy, they do not pay taxes on it. However, beneficiaries should be aware of a few exceptions and conditions.

Life insurance is a financial contract between an individual (the policyholder) and an insurance company, where the insurer promises to provide a designated sum of money, known as the death benefit, to the beneficiaries upon the policyholder’s death. The policyholder pays regular premiums to maintain coverage, offering financial protection and support for loved ones in the event of the insured individual’s passing.

Is Life Insurance Tax-deductible?

In general, life insurance premiums are not tax-deductible. In certain situations, life insurance premiums may be partially or fully tax-deductible. Let us take a closer look at these exceptions

Business-Related Life Insurance

If you use life insurance as part of your business or as a self-employed individual, you may be able to deduct the premiums as a business expense. For example, suppose you have a buy-sell agreement in place to protect your business in case of the death of a business partner, and you pay the premiums for the life insurance policy that covers your partner. In that case, those premiums may be tax-deductible as a business expense.

Certain Employee Benefits

If you are an employee and your employer provides you with life insurance coverage as part of your employee benefits package, the premiums paid by your employer may be tax-deductible as an employee benefit. However, the premiums paid by you, the employee, are not tax-deductible.

Qualified Long-Term Care Insurance

Premiums paid for qualified long-term care insurance, which provides coverage for long-term care expenses, may be tax-deductible subject to certain limitations based on your age and the amount of the premiums. The IRS has specific rules regarding the deductibility of long-term care insurance premiums, and it is advisable to consult with a tax professional to determine if you qualify for this deduction.

Do Life Insurance Beneficiaries Have to Pay Taxes?

No, the policyholder receives the sum assured without paying any taxes. The term plan offers some amazing tax benefits under the Income Tax Act 1961. There are multiple tax deductions to help reduce the tax liability of the beneficiaries.

Benefit Under Section 80C

Under Section 80C of the Income Tax Act 1961, you can get a tax deduction on the money you pay as a premium toward your insurance policy. The tax benefit limit is ₹1.5 lakh. The benefits can be enjoyed by individuals and Hindu Undivided Family (HUF) members.

If the premium value is over 10% of the sum assured, then the maximum limit of the life insurance tax benefit will be 10% of the sum assured. This has been applicable since 1st April 2012. The maximum limit before that was 20% of the sum assured.

Benefit Under Section 10(10D)

Apart from the tax deduction on the premium, the tax benefits can be availed on the money received as the death benefit under Section 10 (10D). As per this section, the nominee of the policyholder can receive the entire sum assured without having to pay any taxes on them. There is no maximum limit to the tax exemption under Section 10(10D).

Where Life Insurance Payout is Taxable?

While life insurance payouts are typically tax-free, certain situations may trigger tax implications. Some of them are as follows:

Case 1: If Interest Accrues on Accumulated Death Benefits

On occasion, policyholders may explicitly state their preference for a delay in the immediate payout of death benefits following their demise. In such instances, the insurance company retains the death benefits for the designated period. Throughout this duration, interest accumulates on the assured sum. Subsequently, when the benefits are disbursed to the beneficiaries, only the accrued interest is subject to taxation.

Case 2: If Payouts Become a Component of the Policyholder’s Estate

In certain scenarios, the beneficiary might predecease the policyholder. Consequently, in the event of the policyholder’s death, the death benefits become integrated into the deceased’s estate. This occurs when there is no nominated individual to whom the insurer can distribute the death benefits. In such cases, the proceeds undergo taxation similar to those applied to the rest of the estate and inheritance.

It is worth noting that this occurrence in India is relatively uncommon because most insurers prompt policyholders to designate both a primary and contingent beneficiary.

How do You Ensure Your Life Insurance Beneficiary will Not Pay Taxes?

Understanding and planning for potential tax implications on life insurance proceeds is essential to ensure that your intended beneficiaries receive the full benefits without the burden of unnecessary taxes.

Name at least One Primary and Contingent Beneficiary

Since a policy payout may be taxable if it goes to your estate, you will want to be sure to designate multiple beneficiaries. By including at least one primary and contingent beneficiary, the odds are good that someone will be around to claim the policy’s benefit tax-free.

Notify Your Beneficiaries

You would be surprised how many life insurance benefits go unclaimed simply because people don’t know they have been named a beneficiary! When you assign a beneficiary, tell them and provide the information for your insurance company so they can easily contact the company to file a claim if you pass away.

Inform Beneficiaries about the Tax Advantages of a Lump Sum Payout

Unless you specify otherwise, the beneficiary can decide how they would like the payment, whether as a lump sum, interest, annuity, or otherwise. When beneficiaries take the benefit as a lump sum, they will receive a single payment to use however they need most, whether to replace income, cover a mortgage, or pay off debt. Other options, like interest and annuity, could result in taxation on the interest income.

What Happens if You Do Not Name a Beneficiary?

Planning for the future is important, and one crucial aspect is ensuring you have designated beneficiaries for your assets. A beneficiary is a person or entity that you have designated to receive your assets in the event of your death. This is typically done by filling out a form with your financial institution, insurance company, or other relevant organization, designating who will receive your assets.

However, what happens if you do not name a beneficiary? Many assume their assets will simply be passed on to their next of kin, but the reality is a little more complicated.

Firstly, if you do not name a beneficiary, your assets may be subject to probate. Probate is a legal process in which a court oversees the distribution of your assets after your death. This process can be lengthy, expensive, and complicated and can tie up your assets for months or even years.

Furthermore, if you do not have a will or other estate planning documents, the court will decide who receives your assets. This can lead to disputes among family members and loved ones, resulting in assets being distributed in a way you would not have wanted.

Additionally, if you do not name a beneficiary, your assets may be subject to creditors’ claims. This means that any outstanding debts or obligations you owe may need to be paid off before your assets can be distributed to your heirs.

When Do Beneficiaries Have to Pay Taxes on Life Insurance Payouts?

Beneficiaries are not obligated to cover taxes on life insurance payouts. However, a common misconception is that life insurance proceeds are invariably tax-free for nominees. Instances where the beneficiary may be required to pay taxes on life insurance payouts include:

Accrual of Interest

If a policyholder specifies a delay in paying the death benefit to the beneficiary immediately after their demise, the insurance company retains the payout, accruing interest over time. When the sum assured is eventually disbursed to the beneficiary, accompanied by the accumulated interest, the recipient becomes liable to pay taxes on the accrued interest.

The Estate Becomes the Beneficiary

If the policyholder designates an estate as the beneficiary or neglects to mention any beneficiary in the life insurance policy, the death benefit becomes integrated into the policyholder’s estate. Additionally, if the primary beneficiary passes away without a contingent beneficiary, the insurance payout is treated as part of the policyholder’s estate. In such scenarios, the sum assured is subject to taxation akin to an estate or inheritance. To mitigate tax obligations, it is essential for the policyholder to name both a primary beneficiary and a contingent beneficiary.

How Does a Life Insurance Beneficiary File a Claim?

Filing a life insurance claim can seem like a daunting task, especially during a time of grief and loss. But knowing what steps to take and what information you need can make the process smoother.

Step 1: Locate the Policy

The first step in filing a life insurance claim is to locate the policy. The policy is a legal contract between the policyholder (you) and the insurance company. The policy will contain all the information you need to file a claim, including the policy number and the insurance company’s name.

If you cannot find the policy, do not worry. You can contact the insurance company directly, and they can help you locate it.

Step 2: Contact the Insurance Company

Once you have located the policy, you must contact the insurance company to start the claims process. You can typically find the contact information for the insurance company on the policy document or their website.

When you contact the insurance company, they will ask you to provide the policy number and basic information about the policyholder, such as their name and date of birth.

Step 3: Gather the Necessary Documents

In order to file a life insurance claim, you will need to provide the insurance company with some documents to support your claim. These documents typically include the following:

  • The death certificate of the policyholder
  • A copy of the policy document
  • Proof of your relationship to the policyholder (if you are not the policyholder)

Step 4: Submit the Claim

Once you have gathered all the necessary documents, you can submit the claim to the insurance company. The insurance provider will examine your claim and could need more proof or information.

If the claim is approved, the insurance company will provide you with the benefits of the policy. This could be a lump sum or regular payments over a set period.

Final Thoughts

Taxing life insurance policies can be complex and confusing, but understanding the rules and regulations can help ensure that you and your beneficiaries receive the maximum benefits from your policy. While beneficiaries typically do not pay taxes on life insurance benefits, there are certain circumstances where they may be subject to taxes.

It is always best to consult a qualified financial advisor or tax professional to fully understand your unique situation and make informed decisions about your life insurance coverage. You can protect your loved ones and leave a lasting legacy with guidance and knowledge.

Key takeaways

  • The policyholder receives the sum assured without having to pay any taxes.
  • The tax benefits are offered under Sections 80C and 10(10D).
  • A beneficiary is a person or entity that you have designated to receive your assets in the event of your death.
  • Life insurance policies are typically paid out in a lump sum, meaning your beneficiaries will receive the total amount of the policy in one go.
  • Gifting a life insurance policy may trigger gift tax considerations, especially if the policy has a cash value.
  • If beneficiaries choose to take out loans or make withdrawals from a life insurance policy’s cash value, these transactions may be taxable depending on the circumstances.

- A Consumer Education Initiative series by Kotak Life

Amit Raje
Written By :
Amit Raje

Amit Raje is an experienced marketer who has worked in various Fintechs and leading Financial companies in India. With focused experience in Digital, Amit has pioneered multiple digital commerce in India. Now, close to two decades later, he is the vice president and head of the D2C business department. He masters the skill of strategic management, also being certified in it from IIMA. He has challenged his challenges and contributed his efforts in this journey of digital transformation.

Amit Raje
Reviewed By :
Prasad Pimple

Prasad Pimple has a decade-long experience in the Life insurance sector and as EVP, Kotak Life heads Digital Business. He is responsible for developing user friendly product journeys, creating consumer awareness and helping consumers in identifying need for life insurance solutions. He has 20+ years of experience in creating and building business verticals across Insurance, Telecom and Banking sectors

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