Section 10 (10D) of the Income Tax Act, 1961 on Payouts of Life Insurance Policy

Life insurance is a critical component of financial planning, that provides security to policyholders and their families. One of the significant benefits of life insurance is the tax exemptions available under Section 10(10D) of the Income Tax Act 1961.

Key Takeaways

Section 10D of Income Tax Act governs tax exemptions on life insurance payouts, and understanding its terms is crucial for informed financial decisions.
To avail of the benefits under the policy, life insurance must be in force for 2+ years and issued after April 1, 2012.
Section 10 (10D) of Income Tax Act exempts the policyholder’s nominee or legal heir from paying taxes on the death benefit.
This Section helps in monitoring policy performance and staying updated on amendments regarding tax implications.
As per the latest amendment, the maturity benefit of ULIPs issued after February 1, 2023, will only qualify for the Section 10 (10D) tax exemption if the annual premium paid does not exceed ₹2.5 lakhs.

Section 10 (10D) provision ensures that the payouts received from a life insurance policy are exempt from tax and subject to certain conditions. It is essential to understand Section 10 (10D) for making informed decisions about life insurance investments and maximizing tax benefits.

Understanding the Importance of Section 10 (10D)

Various sections of the Income Tax Act 1961 help with tax savings. Section 10 (10D) is one such important provision that deals with the tax implications of the life insurance policy. Understanding this Section is crucial as it determines the taxability of the policy proceeds and the tax benefits that the policyholder can avail of

Background on Taxation Under Section 10 (10D)

Section 10 (10D) of the Income Tax Act 1961 deals with the taxation of life insurance policies. This Section was introduced in the Finance Act 2003 and has undergone several amendments since then.

The main objective of Section 10 (10D) is to provide tax benefits to policyholders who purchase life insurance policies. According to this Section, the proceeds of a life insurance policy are exempt from tax if certain conditions like the following are met:

The exemption applies only to policies that satisfy the minimum sum assured requirement.
The sum assured should be at least 10 times the annual premium paid for policies issued on or after April 1, 2012, and 5 times the annual premium for policies issued before that date.
It is applicable only if the policy is not surrendered or terminated during the policy term. If the policy is surrendered or terminated before the completion of the policy term, the exemption will not be available. However, the exemption will be available if the policy is surrendered or terminated due to the policyholder’s death.
Thirdly, the exemption applies only to policies issued on or after April 1, 2003. Policies issued before this date are not eligible for the exemption.

It is important to note that the exemption under Section 10 (10D) applies only to the proceeds of a life insurance policy and not to the premiums paid. The premiums paid for a life insurance policy are not deductible from the taxable income of the policyholder.
Apart from the exemption under Section 10 (10D), other tax benefits are associated with life insurance policies. The premiums paid for life insurance policies are eligible for tax deductions under Section 80C of the Income Tax Act. The maximum deduction allowed under this Section is ₹1.5 lakh per annum.

Understanding Section 10 (10D): Eligibility Criteria and Benefits

Section 10 (10D) is designed to encourage people to invest in life insurance, and it provides policyholders with several tax benefits and exemptions.

Eligibility Criteria

The policyholder must meet certain criteria to be eligible for tax benefits under Section 10 (10D). These include:

The policy must be a life insurance policy, which means that it must provide coverage in the event of the policyholder’s death.
The policy must be in force for a minimum of two years. If the policy is surrendered or canceled before this period, the tax benefits will not be available.
The policy must be issued on or after April 1, 2012.

Benefits of Section 10 (10D)

The main benefit of Section 10 (10D) is that it offers tax exemption on the life insurance policy proceeds. This means that the death benefit paid to the nominee or legal heir of the policyholder will not be taxable. The maturity benefit the policyholder receives at the end of the policy term is also exempt from tax.

Section 10 (10D) Exemption Towards Amount Received Under a Life Insurance Policy

Beyond just maturity benefits, Section 10 (10D) also covers other amounts received under certain life insurance policies:

Death Benefit: The sum assured received by the nominee upon the policyholder’s death is fully exempt from tax under Section 10 (10D).

Surrender Benefit: If the policyholder surrenders the policy before maturity, the surrender benefit received may be partially or fully taxable depending on the specific policy terms and conditions.

Calculating Taxable Amount Under Section 10 (10D)

Suppose Mr. Kumar purchased a life insurance policy for ₹5 lakhs and has been paying an annual premium of ₹50,000. After five years, he decided to surrender the policy, and the surrender value was ₹3 lakhs. In this case, the surrender value of ₹3 lakhs will be exempt from tax under Section 10 (10D) since the policy has been held for more than two years.

Steps

First of all, determine the proceeds received from the transfer of the life insurance policy. Now, subtract the premium paid from the proceeds received to arrive at the taxable amount.

If the policy were transferred before the completion of two years, the entire amount would be taxable. However, if the policy was transferred after the completion of two years, the taxable amount will be calculated as follows:

For policies taken on or after April 1, 2003, but before April 1, 2012, the taxable amount will be calculated as the lower of the following two amounts:
20% of the proceeds received from the transfer of the policy
The total amount of premiums paid for the policy till the date of transfer.
For policies taken on or after April 1, 2012, the taxable amount will be calculated as the lower of the following two amounts:
10% of the proceeds received from the transfer of the policy
The total amount of premiums paid for the policy till the date of transfer.

Advantages of Term Insurance Regarding Section 10 (10D)

One of its significant advantages is the tax benefits associated with it under Section 10 (10D) of the Income Tax Act, 1961. Here are the key advantages of term insurance regarding Section 10 (10D):

Tax-free Death Benefit: The death benefit received by beneficiaries is completely tax-free, providing financial security without tax burdens.
Tax Deduction on Premiums: Premiums paid for term insurance qualify for tax deductions under Section 80C, up to ₹1.5 lakhs per annum.
High Coverage, Low Cost:Term insurance provides substantial coverage at low premiums.
Financial Security for Dependents: Guarantees full sum assured to beneficiaries without tax deductions.
No Upper Limit on Exemption: No upper limit on the tax exemption for the death benefit.

Simplicity: Straightforward policies with clear tax benefits.

Best Practices for Utilizing Section 10 (10D)

Section 10 (10D) is an important feature that allows policyholders to make partial withdrawals or loans against the policy’s cash value. This provision can be an essential tool for managing finances, but it is important to use it correctly to maximize its benefits. Best practices for utilizing Section 10 (10D) of life insurance policies:

Understand the Policy’s Terms and Conditions

Before utilizing Section 10 (10D) of a life insurance policy, it is essential to understand the terms and conditions of the policy. Review the policy document carefully, paying attention to the fees, interest rates, and any penalties associated with withdrawals or loans. It is also important to understand how the policy’s cash value is calculated, as this will determine the amount that can be withdrawn or borrowed. If you have any questions about the policy’s terms and conditions, contact your insurance provider or financial advisor for clarification.

Use Section 10 (10D) Strategically

Section 10 (10D) of a life insurance policy can be a valuable tool for managing finances, but it is essential to use it strategically. Consider using this provision to fund short-term expenses, such as a child’s college tuition or unexpected medical bills. However, it is important to remember that any withdrawals or loans made against the policy’s cash value will reduce the death benefit paid out to your beneficiaries. Therefore, it is best to use Section 10 (10D) sparingly and only when it is absolutely necessary.

Deduction Limit under Section 10 (10D)

Monitor the Policy’s Performance Regularly

Regularly monitor your life insurance policy’s performance and premium payments to ensure compliance with Section 10 (10D) criteria. Adjust your premiums if necessary to maintain eligibility for tax exemptions.

Maturity Return Requirements Under Section 10 (10D) of the Income Tax Act

Section 10 (10D) of the Income Tax Act specifies exemptions from income tax on amounts received under life insurance policies. However, not all maturity returns automatically qualify for this exemption. To be exempt, the following conditions must be met:

Policy Issued Before April 1, 2012

For policies issued before this date, no limit is set on the premium paid compared to the sum assured. The entire maturity benefit received by the policyholder is tax-free.

Policy Issued After April 1, 2012

For policies issued after this date, the premium paid cannot exceed 10% of the sum assured for the maturity benefit to be exempt from tax. If the premium exceeds 10%, the portion exceeding 10% of the sum assured will be taxable as income.

Additional Exemptions

Certain specific types of policies offer additional exemptions regardless of the above conditions. These include:

Policies for Persons with Disabilities (Section 80U): Maturity benefits received under life insurance policies for individuals with disabilities are exempted from tax, regardless of the premium paid.
Critical Illness Cover Riders: Additional benefits received under Critical Illness riders attached to life insurance policies are exempted from tax.

Budget Amendment to Section 10 (10D) for High Premium ULIPs

The recent Union Budget introduced provisions to address concerns about high-premium Unit-Linked Insurance Plans (ULIPs). These amendments limit the tax exemption under Section 10 (10D) for ULIPs.

For ULIPs issued after February 1, 2023, only if the annual premium paid does not exceed ₹2.5 lakhs will the maturity benefit qualify for the tax exemption under Section 10 (10D). If the premium exceeds ₹2.5 lakhs in any year, the maturity benefit will be partially taxable.

Final Thoughts

Section 10 (10D) provides several advantages for policyholders. From receiving tax-free death benefits to strategically utilizing surrender value options, this Section offers valuable tools for managing financial needs throughout your life. However, it is crucial to remember the eligibility criteria and potential tax implications of different scenarios. By carefully reviewing your policy terms and seeking professional guidance when needed, you can unlock the full potential of Section 10 (10D) and leverage its benefits for a secure financial future.

FAQs on Section 10 (10D) of Income Tax Act

What comes under Section 80U?

Section 80U covers medical expenses incurred for yourself, your spouse, dependent parents, and children. It also covers hospitalization, surgery, diagnostic tests, and treatment for specific diseases.

What comes under Section 80DDB?

Section 80DDB offers higher deductions for medical expenses related to specific ailments like cancer, neurological diseases, and kidney diseases. It applies to expenses for your parents or dependent parents.

What are some points to keep in mind regarding Section 10 (10D) of the Income Tax Act?

Section 10 (10D) exempts income from housing allowances received by government employees. It applies to allowances for rent, hostel, and other house-related expenses. Specific limits and conditions apply based on location and pay grade.

What is Section 10 (10D) of Income Tax Act?

Section 10 (10D) provides tax exemptions for any sum received under a life insurance policy, including death and maturity benefits, subject to certain conditions.

What is the Section 10 (10D) exemption limit?

There is no upper limit on the exemption amount under Section 10(10D). However, the policy premiums must adhere to specified limits to qualify for the exemption.

What is the Section 10 (10D) amendment in Budget 2023?

The Budget 2021 amendment stipulates that proceeds from ULIPs with annual premiums exceeding ₹2.5 lakhs will be taxable, aligning their tax treatment with that of mutual funds.