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Tax Benefits in life insurance policies explained
Mar 06, 2019 | 356 VIEWS
It is the tax saving season and a lot of you will be buying life insurance policies to meet the tax exemption criteria and save some money. While it is a very good idea, you should keep few points in mind so that you don’t run into some unexpected trouble with your tax saving endeavours. So here is a brief primer on the things you should keep in mind.

Note: Not all life insurance policies provide tax benefits. Be extra careful when buying single premium plans. You may face some nasty surprises.

Section 80C of the Income Tax Act - This section allows a total deduction of Rs. 1,50,000 to be deducted from your annual income for the purpose of calculating the tax payable by you for the year. Now you can invest in a number of financial instruments like PPF, NSC, Mutual Funds and Life Insurance Policies to name a few.

I will restrict this video to life insurance itself. There are scenarios wherein the tax benefits may not be applicable to you in case you do not buy the correct life insurance policy. So let us understand those scenarios so that you can avoid those mistakes and avoid scenarios where you invested thinking you will get tax benefits, but actually will not get any benefits.

Scenario 1 - For any life insurance policy, the gross premiums you pay exceeds 10% of the actual sum assured, then the tax deduction will only be to the extent of 10% of the sum assured in the plan. This often goes wrong when you take single premium life insurance policies in a hurry to save tax.

Let us understand this with an example. Suppose you buy a life insurance policy with the following parameters:

Sum Assured - Rs. 7,50,000
Single Premium - Rs. 1,50,000

Note: The premium is greater than 10% of the Sum Assured.
You buy this policy wanting to maximise on the 1,50,000 tax deductions available to you. But in reality, you can claim benefits only to the extent of 10% of the Sum Assured. So though you have paid Rs. 1,50,000 you can claim tax benefits only for 10% of 7,50,000 = Rs. 75,000.

What makes this worse? In the above scenario, your entire maturity benefit is actually taxable and this can be very costly to you.

For policies issued on or before 31st March 2012, the above limit was 20%.

Scenario 2 - You don’t continue the policy after buying it. This can also lead to problems and you will have to pay additional tax. The benefits which you had claimed in the earlier years would need to be reversed in the year of discontinuation. So let us now understand for how long you should hold the life insurance policy so that you do not have a problem.
  • ULIPs - You need to continue paying premiums for at least 5 years and keep it active.
  • Single Premium Plans - The plan needs to be active for at least 2 years.
  • Other life insurance plans - You have to pay premiums for at least 2 years and keep it active for that period.

These are some of the points which I wanted to cover. Please keep them in mind while you buy life insurance policies in this tax season.

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