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Life insurance and Its tax implications

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Normally people do their investment planning at the fag end of the month of March, hence majority of life insurance policies are purchased on tax considerations only and that too in the last quarter of the financial year. No wonder, many of end up committing some mistakes while buying insurance, just in a hurry to save tax. However, now that we are through with the last minute activity, and have entered into the new financial year, it is time that we take a fresh look at the various provisions on insurance as contained under the income tax laws.

Here I intend to discuss the aspects of tax treatment of Life Insurance Premium as well as tax treatment of money received from insurance company. Since implementation of DTC in the immediate future is doubtful, I have deliberately skipped discussion on DTC.

Quantum of Deductions for payment of premium:

Under the present provisions of Section 80 C, deduction in respect of life insurance premium paid is available up to a maximum of Rs. 1 lakh. This deduction is available with other eligible items like tuition fee of your children, EPF, NSC, ELSS and repayment of principal amount of home loans etc. This deduction is available for life insurance polices, on the life of yourself, your spouse or your child, though child may be major or a minor or even married or unmarried. This particular aspect can be used for tax planning.

In case of senior citizens, normally they do not have much to claim, which qualifies under Section 80C and thus the limit of one lakh in majority of the cases does not get fully utilized. In such cases they can opt to pay the life insurance premium of their earning and grown up sons or daughters. This is because in the case of the grown up sons and daughters, the limit of Rs. 1 lakh, in majority of the cases is already used up by school fees and repayment of home loans, thus life insurance premium can-- not be claimed under Section 80C. Financial dependence of son or daughter on parent is not the requisite for claiming tax benefits on insurance premiums by parents.

One more aspect about claiming tax benefit for life insurance premium, not generally known to many, that it is not necessary that the premium should be paid by the same person year after year. This can be paid and claimed by different person as long as the same is paid to keep the life insurance policies in force on the life of persons specified in Section 80 C. Thus shortfall in parents' accounts can be filled in from surplus of the earning and grown up children's account from time to time.

Please note that there is no restriction on the number of children in respect of whom you can pay the premium and claim this deduction unlike for tuition fee where the deduction can only be claimed for two children.

Restrictions on Life Cover required for calming the deduction:

As per Section 80 C, the quantum of premium, which can be claimed is restricted in relation to the amount of the sum assured. As per the provisions applicable from April 1, 2012, any premium paid in excess of 10% of the sum assured should not be allowed under Section 80 C. Earlier this limit was 20% of the sum assured. For this purpose the sum assured means that the minimum amount which the insurance company has agreed to pay in the event of death. This amount will not include any bonus payable on such policy. Moreover any premium to be refunded shall also not be considered while calculating the sum assured.

Restriction on continuance of the Life Insurance Policy

In order to ensure that the deductions claimed in respect of premium paid earlier is not withdrawn in any year; subsequently you are required to keep the life insurance policy alive for a certain number of years. In case of a single premium policy, you cannot terminate the policy within two years from the date of commencement of the Life insurance Policy. In case of any other life insurance policy, the tax benefits granted to you shall be added to your income subsequently if you do not pay the insurance premium for two years in respect of that policy.

Tax Treatment of money received from Insurance Company

Generally people perceive that all monies received from Insurance Companies are exempt. This is not so. Section 10(10) provides for exemption for money received from insurance company in respect of insurance policy. First amount received in respect of all Key man Insurance policies are taxable. Secondly money received on death in respect of all the life insurance policies are exempt except those issued as key-man's insurance policy.

In respect of money received from Insurance Company other than in the event of death on all life insurance policies issued prior to April 1, 2003 will also be exempt from tax. However in respect of life insurance polices issued on or after April 1, 2003 but before March 31, 2012, money received from insurance company, other than on death, shall become taxable if premium payable in respect of this policy exceeds 20% of the sum assured in any of the year. However in respect of policies issued after March 31, 2012, the same will become taxable in the hands of recipient if the premium in respect of such policies exceeded 10% of the sum assured in any year.

In addition to above any money received in case of life insurance policy purchased for maintenance of physically disabled person under Section 80DD if such person dies before the proposer the money received by the proposer shall also be taxable.

So from the above discussion it becomes amply clear that you should take into account various factors before you buy any life insurance policy so that the premium paid is allowed and the money received in respect of such insurance policy is does not become taxable.

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