Tax Benefit of Investing in Term Plan

Key takeaways

• Term insurance is an insurance policy that offers life cover for a certain period of time and does not have a maturity benefit.
• The Income Tax Act, 1961 provides tax benefits on term insurance premiums under specific sections.
• Section 80C of the Income Tax Act provides a deduction of up to ₹1.5 lakh for the premiums paid towards life insurance policies, including term insurance plans.
• Besides saving tax through premiums, the insured may avail themselves of tax exemption on the death benefit amount.

The market is flooded with a plethora of life insurance products. There are numerous insurance plans available, namely endowment plans, whole life insurance plans, annuity plans, and money plans, among others. Each of these insurance plans has a different financial goal, which may vary from individual to individual.

What is Term Insurance?

Term insurance is an insurance policy that offers life cover for a certain period of time and does not have a maturity benefit. In case of the policyholder’s death during the term, the insured’s loved ones will be paid the death benefit. This amount may be used to cover income loss in case the policyholder is the breadwinner of the family. Besides, it may be used to cover unpaid debt as well as meet other financial obligations.

It is important to note that there is no maturity benefit in a term life insurance plan. This means that in case you outlive the policy tenure, no benefits are paid. Such a plan offers only coverage against death, and hence such a plan is known as a pure life cover.

The good news is that insurance providers charge a low premium amount for term plans. In fact, premiums charged for this type of insurance are the lowest among all other types of life insurance plans. This is because the entire amount is used to cover risk and is not used for further investment.

Term Insurance Tax Benefits under Specific Sections of the Income Tax Act, 1961

Term insurance is a type of life insurance that provides coverage for a specific period of time. It is an affordable and simple form of insurance that ensures the financial security of your loved ones in case of your untimely demise. Along with providing financial protection, term insurance also comes with various term plan tax benefits.

The Income Tax Act, 1961 provides term life insurance tax benefits under specific sections. Following tax benefits are available on term insurance under these sections:

Section 80C

Section 80C of the Income Tax Act provides a deduction of up to ₹1.5 lakh for the premiums paid towards life insurance policies, including term insurance plans. This deduction can be claimed by an individual or a Hindu Undivided Family (HUF). However, to avail of this benefit, the sum assured of the term insurance policy must be at least 10 times the annual premium paid.

Section 80D

Term insurance comes under 80C or 80D of the Income Tax Act and provides term plan tax benefits on health insurance premiums. If you have purchased a term insurance plan with an inbuilt critical illness rider or any other health-related rider, then the premium paid for these riders can be claimed as a deduction under term insurance tax benefit 80D. The maximum deduction available under this section is ₹25,000 for individuals and ₹50,000 for senior citizens.

Section 10(10D)

Section 10(10D) exempts the maturity proceeds of a life insurance policy. If the sum assured is at least 10 times the annual premium paid, then the entire maturity amount received by the policyholder is tax-free. This provision is applicable to both individual and HUF taxpayers.

Eligibility criteria to claim tax benefit

The most widely used method for individuals to reduce their tax burden is Section 80C of the Income Tax Act. A maximum deduction of ₹1.5 lakh is available under this section for all of the specified investments and instruments taken together. It consists of various investment alternatives like PPF, EPF, ULIP, and ELSS, as well as payments for things like home loan repayment, child’s tuition, life insurance premiums, etc.

The premium paid towards term life insurance is exempt from taxes under this section, allowing the policyholder to avail themselves of deductions up to ₹1.5 lakhs (total of all investments and payments under this Section).

Section 80C’s eligibility requirements for the tax advantage for term insurance include:

• The annual premium should be less than 10% of the assured amount. If the premiums do go beyond 10%, deductions will be made in a commensurate manner.
• For insurance issued before March 31, 2012, the discount is applicable only when the annual premium does not exceed 20% of the sum guaranteed.
• The policyholder won’t be eligible for Section 80C tax benefits on premium payments if the policy is voluntarily relinquished or canceled before the two-year mark, according to Section 80C (5).

Term Insurance Under Section 10D

Besides saving tax through premiums, the insured may avail themselves of term insurance tax exemption on the death benefit amount. In case of the policyholder’s death, their family/nominee is entitled to receive the death benefit. Section 10D states that this death benefit amount is totally exempt from tax. This benefit may therefore be availed of by the beneficiaries to reduce tax liability. The good news is that there is no upper limit on the tax benefit.

This clause, however, is not applicable under the following circumstances:

• If the amount is received under Section 80DD (3). This includes deposits made towards maintenance, which includes medical treatment of handicapped dependents.
• If the amount is received under the Keyman Insurance Policy
• If the amount is not a part of the death benefit for the policy issued on or after 1st April 2003 but on or after 31st March 2012. Besides, such a benefit is not applicable if the total premiums paid during the policy term are more than 20% of the sum assured amount received.
• In the event that the term plan is issued on or after 1st April 2012, you may avail of exemption benefit only if the total premium paid does not exceed 10% of the sum assured amount.

Term Insurance Tax Benefits under Section 80D

Term insurance is one of the most beneficial products from all perspectives. Not only does it help you protect your family’s financial security, but it also gives you tax benefits. You have already seen how it benefits under Section 10D.

Term insurance comes under 80C or 80D, so it offers a deduction of ₹25,000 on premiums that go towards a term plan with critical illness cover.

Limitations on Term Insurance Tax Benefits

• If the amount of premium paid during a financial year is greater than 20% of the sum promised, the tax benefit is available for an amount up to 20% of the total assured.
• If the premium amount for a policy issued after April 1, 2012, does not exceed 10% of the actual sum guaranteed, you may be eligible for an income tax credit under the IT Act.
• If the policy is issued after April 1, 2012, and your premium amount is less than 10% of the actual sum assured, you may be eligible for benefits if you have a specific illness or severe disability.

Exceptions on Tax Exemption Rule

The beneficiary may be required to pay taxes on the term insurance payout in one of two situations.

One instance is when the policyholder specifies in their application that the death benefit cannot be paid immediately after the decedent passes away. In these situations, the insurance provider retains the money and pays it once the interest-bearing term has passed. The beneficiary’s interest payment is considered taxable. Instead of the promised amount, the beneficiary must pay tax on the interest generated since the policyholder’s passing.

In another scenario, when the proceeds from the policy come in the form of an inheritance, the beneficiary is responsible for paying tax on the term insurance. When the policyholder omits the nominee’s information, the policy benefits occasionally go to the deceased’s estate.

Even though these situations are uncommon, when they do occur, the insurance proceeds become a component of the decedent’s estate and are, therefore, subject to inheritance tax. As insurance firms require the policy buyers to include information regarding the primary and secondary beneficiaries, this rarely occurs. The secondary beneficiary is entitled to the payout if the primary beneficiary dies before the policyholder.

Wrapping Up

Investing in a term plan not only provides financial protection to your family but also offers tax benefits. The premiums paid towards the term plan are eligible for tax deductions under Section 80C of the Income Tax Act up to a limit of ₹1.5 lakh per year. Additionally, the death benefit received by the nominee is also tax-free under Section 10(10D) of the Income Tax Act.

These tax benefits make term plans an attractive investment option for individuals who want to secure their family’s financial future while also optimizing their tax liability. It is important to note that while tax benefits should be a consideration, the primary reason to invest in a term plan should always be to provide financial protection to your loved ones in case of an unfortunate event.