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A Guide to Life Insurance Policy’s Tax Benefits and Taxability

Life insurance offers tax-deferred growth on the cash value portion of the policy, meaning your money compounds interest without being taxed until you withdraw it.

  • 13,281 Views | Updated on: Mar 12, 2024

Life insurance plans are a great way to reduce your tax burden and save money. Some life insurance policies, such as term life policies, are exempt from taxes, so you would not have to pay taxes on dividends, death benefits, or other payouts.

Buying a life insurance plan is very important for people who have dependent family members. The policy will help you protect the financial future of your parents, spouse, and children. When it comes to finding suitable life insurance coverage, insurance companies in India provide a variety of choices. Along with benefits, there is also some leverage for the life insurance taxation for the policyholders.

Understanding Life Insurance

Life insurance is a financial product that provides a lump-sum payment, known as the death benefit, to the beneficiaries in the unfortunate case of the insured person’s death. This payment is designed to provide financial protection to the family or dependents of the insured in the event of their death.

Tax Benefits on Buying a Life Insurance

India’s Income Tax Act of 1961 offers tax benefits specifically designed for life insurance policies. These benefits cater to all types of policies, empowering you to save on taxes while securing your future and that of your loved ones. Three key sections act as the guardians of these benefits: Section 80C, Section 80D, and Section 10(10D)

Deduction under Section 80C

Under section 80C of the Indian Income Tax Act, 1961, any premium paid towards a life insurance plan for yourself, your spouse, and your children is tax-deductible. An important point to remember is that to get the benefit for any policy issued on or after April 1, 2012, the premium you pay should be less than 10% of the sum insured.

Exemption under Section 10(10D) on the maturity benefit

Section 10(10D) of the Income Tax Act allows term insurance tax exemption on the maturity benefit and bonuses received from your life policy. To be eligible for this income tax deduction, the premium you paid must not be more than 20% of the sum assured for policies issued before April 1, 2012, and 10% for the policies issued after April 1, 2012.

Exemption under Section 80D

Under Section 80D, individuals can claim a deduction of ₹5,000 for expenditures related to preventive health check-ups. This deduction falls within the overall limit of ₹25,000/₹50,000, depending on the specific case. Furthermore, this deduction is applicable to the individual, their spouse, dependent children, or parents.

GST Exemption

There is an 18% GST levied on life insurance premiums. However, some specific situations exist where you might be eligible for a GST waiver or reduction.

  • Non-Resident Indians (NRIs) can claim a GST waiver on term insurance premiums paid using an NRE (Non-Resident External) account. This waiver applies to annual premium payments and can significantly reduce the cost of term insurance for NRIs.
  • Life insurance policies with a sum assured of up to ₹50,000 falls under the micro-insurance category and attract a reduced GST rate of 5%.

How can Life Insurance Plans Reduce your Tax Burden?

With life insurance, you can use your policy’s cash value to take out policy loans and pay for large expenses without paying taxes on the loan amount, which can be an attractive option for those looking to reduce their tax burden. Using a life insurance plan will allow you to reduce your tax liability under the Income Tax Act of 1961. You can receive term insurance tax benefits at certain times throughout the insurance.

Tax Benefits on Maturity

The maturity amount received from a term insurance plan is tax-free. You do not have to pay taxes on the maturity amount your term insurance plan receives.

Tax Benefits on Death

The death benefit received from a term insurance plan is also tax-free. Your beneficiaries will not have to pay taxes on the death benefit from your term insurance plan.

Tax Benefits on Surrender

The surrender value received from a term insurance plan is also tax-free. It means you do not have to pay taxes on the surrender value received from your term insurance plan.

When the Maturity Benefit is Taxable?

There are certain situations when Section 10(10D) does not apply to the maturity benefits. If the premium you paid towards the life insurance policy is more than 10% of the sum assured for policies issued after April 1, 2012, you will not receive the tax benefit. For policies bought before April 1, 2012, you will not be eligible for the tax benefit if the premium paid is over 20% of the sum assured. This rule for the taxability of the life insurance maturity amount is an important one to remember.

TDS on the life insurance policy

Since October 2014, insurance companies have been eligible to implicate 1% Tax Deducted at Source(TDS) on the life insurance benefit if the amount is more than ₹1 lakh. It was raised to 5% from the previous TDS of 1% in the Union Budget 2019. TDS is also applicable to the bonuses received by you. When filing your tax return, you are entitled to receive credit for the TDS the insurer charges.

Tax implication of single premium life insurance policies

For a single premium payment life insurance policy, the premium paid is often more than 10% of the sum assured. Hence, the maturity benefit of the policy will be taxable. For example, if you bought a policy with a maturity value of ₹1.1 lakhs on September 16, 2013, the single premium will be approximately ₹45,000, over 10% of the sum assured. If you surrendered the policy on September 16, 2019, the insurer would charge 5% TDS on the net maturity proceeds.

What Tax Advantages Do Life Insurance Riders Offer?

Life insurance providers offer a variety of riders to augment coverage, and these additional features extend beyond mere protection. Policyholders may qualify for supplementary tax benefits depending on the chosen life insurance rider and specific terms.

  • Life insurance plan riders can contribute to extra tax advantages in the following ways: By incorporating the Critical Illness rider into your term plan, you become eligible for tax deductions under Section 80D.
  • For riders such as Return of Premium, selected during the purchase of a term plan, the premium experiences an increment. This increment facilitates greater savings under Section 80C. Utilizing an online term insurance calculator can help assess how these riders affect the premium amount.

What Does Goods and Services Tax (GST) Imply for Life Insurance Policies?

No revisions to the Goods and Services Tax (GST) applied to life insurance policies have been made. For Indian residents residing abroad, there is an option to avail of an 18% GST waiver on premiums paid for maintaining an active-term insurance policy for NRIs. This waiver provides an opportunity to enhance savings on life insurance plan tax benefits in accordance with the regulations outlined in the Income Tax Act of 1961.

Wrapping Up

It is important to realize that while tax advantages on premiums and payouts may be an added benefit of life insurance, they are not the main goal of having a policy. The main purpose of life insurance is to provide your dependents with financial security in the event of your passing. Therefore, you must first comprehend a policy’s ins and outs in order to make the best decision.

Key Takeaways

  • Life insurance policies offer a number of benefits to the policyholders, including tax benefits.
  • These benefits are applicable under different income tax sections, such as section 80C, section 80D, and section 10(10D).
  • Currently, there have been no revisions to the GST applied to life insurance policies. NRIs may avail themselves of an 18% GST waiver on premiums for active-term insurance policies.
  • Insurance companies impose TDS (Tax Deducted at Source) on life insurance benefits exceeding ₹1 lakh, raised from 1% to 5% in the Union Budget 2019.

- 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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