Insurance and Taxes

Insurance and Taxes

What is insurance and taxation?

Insurance is a legal contract/agreement between two parties; the insured and the insurer, where the insured is promised financial compensation by the insurer when a certain event occurs such as the death of the insured or a critical illness. To get financial coverage, the insured is required to pay a set amount of money to the insurer monthly and this amount is known as a premium. Many types of insurance plans exist and some of the common types are term insurance, life insurance, and health insurance. 

An insurance policy is best purchased early on in life as the premiums are lower. Some insurance providers specify when a policy can be purchased. Generally, the later you buy, the more expensive it becomes. Instead of only opting for the insurance policy, you can select riders which are add-ons to ensure you get the coverage you need depending on your specific requirements. This allows you and your loved ones to be protected in a wide range of scenarios and gives you peace of mind knowing that your dependents will get sum assured when the conditions are met. 

Taxation is when the government (or the authority responsible for levying taxes) imposes financial taxes on individuals based on a set of pre-determined conditions. It is applicable when a person earns a certain amount during a financial year. In India, the Income Tax Department is the taxing authority and the Income Tax Act, 1961 is the statute used to impose taxes and perform collection, administration, and other tax-related activities. The income tax rules and regulations may change from time to time and it is your job to ensure you are aware of what affects you and how. 

One of the most common taxes is income tax. It is levied on a person’s income earned yearly. In India, there are tax slabs based on which the percentage of tax to be paid is specified. It also depends on your age and the category. Typically, the more you earn, the more tax you need to pay to the government. It is important to furnish all details regarding your income sources when you are filing taxes to ensure no penalties are imposed on you. You can save on income taxes by buying insurance policies.

What are the tax benefits of insurance?

The policyholder can enjoy insurance tax benefits when he buys a life insurance plan, term insurance policy, and/or health insurance plan. There is generally a limit on how much income tax deduction the policyholder can claim, but it can be used to substantially decrease income tax. There are multiple ways in which a policyholder can use his insurance policies to avail of tax benefits. These depend on the type of insurance purchased and the pre-determined conditions of claiming benefits. 

You can avail of tax benefits under life insurance policies as per Sections 80C, 80CCC, 80CCE, 10(10A), and 10(10D) in the Income Tax Act, 1961. You can avail of term tax benefits of life insurance policy as per Sections 80C, 80D, and 10(10D). You can get deductions on health insurance for tax purposes as per Section 80D. Each section specifies who is eligible to claim, what they can claim a deduction on, and how much they can claim. 

The reason why the Indian government gives deductions for insurance policies is that it wants to encourage the public to safeguard themselves and their dependents in case the worst scenario plays out. By purchasing insurance policies, the policyholders and their families have a safety net because they will have the means to sustain themselves without worrying about the financial aspect for a period of time. 

As income tax laws are subject to change, it is best to refer to the Income Tax Department’s official website to understand the latest additions to how you can save tax by purchasing different insurance policies. If you do not currently have any type of insurance, now is the perfect time to get it because you can save when you pay your annual income tax and also protect your family in case anything happens to you, the policyholder. 

Tax benefit from life insurance

A life insurance policy is a contract between the insurer and the policyholder whereby a lump-sum amount is provided to the dependents of the insured in case of the policyholder’s death or upon maturity. The policyholder pays a monthly premium to get this cover and save his family from financial problems later in case the policyholder unexpectedly dies during the period. A term life insurance policy is one of the most common types of life insurance policy because of its affordability and simplicity.

The policyholder can receive life insurance tax benefits under the following sections of the Income Tax Act, 1961. 

Section 80C

The policyholder can receive a tax deduction of a maximum of Rs. 1.5 lakh on the premium paid towards a life insurance plan. The life insurance policy can be taken for himself, his spouse, or his children. Note that the actual deduction is up to 10% of the minimum premium the policyholder pays or the capital sum assured; whichever value is lower. This applies to policies purchased after 1st April 2012. For the policies purchased before that, a policyholder can get a deduction of up to 20% on the sum assured of the life insurance policy. 

Note that there is another important condition under this section. If the life insurance policy is surrendered by the policyholder or it is terminated for whatever reason before 2 years from the commencement date, then the policyholder cannot get the life insurance tax benefits outlined in this section. It is only if he has been continuously paying the life insurance premium for at least 2 years that he can get the deductions mentioned in this section. 

Section 80CCC

When the policyholder purchases retirement plans or pension policies, he can avail of a maximum of Rs. 1.5 lakh as a life insurance exemption in income tax. If the policyholder cancels or surrenders the policy, then he is liable to the normal tax laws as specified in the Income Tax Act, 1961. The tax is levied on the pension or annuity received by the policyholder and this can have many benefits because the saved income can be used as retirement savings.

Section 80CCE

The policyholder can receive a tax benefit of up to Rs. 1.5 lakh on the taxable income which means the deduction is capped at this value under Sections 80C, 80CCD(1), and 80CCC. If you earn a considerable amount yearly, then this tax benefit can cut down the income tax you need to pay by a significant amount. You should ensure you meet the eligibility criteria for each section so you can file for a deduction under each section. 

Section 10(10A)

As per this section of the Income Tax Act, 1961, the policyholder is exempted from paying income tax on a third of the payment received when he retires and when he receives the gratuity. In other cases, the policyholder is exempted from paying income tax on half of the gratuity he receives. This can have considerable tax saving benefits thereby ensuring you can protect your family from financial burden and save tax at the same time. 

Section 10(10D)

The proceeds from the life insurance plans are exempt as stated in this section if they meet the conditions specified. This means the sum assured plus the bonus if applicable in the life insurance policy is tax-free in case of the death of the policyholder or the policy maturity has been reached. The deduction is also applicable to gains from a ULIP and those on maturity proceeds when the premium paid is up to 10% of the sum assured. 

Tax benefit from term insurance

Term insurance provides cover during the policy term. That is, you need to purchase a policy for a certain number of years until which you are covered. You can get a term insurance policy when you are 18 years old when it is the cheapest. The term insurance policy is the simplest way of getting the most affordable policy but it is limited in its benefits. You can purchase a term insurance rider for broader coverage and more protection. 

The policyholder can receive numerous term insurance tax benefits as stated in the Income Tax Act, 1961.

Section 80C

When a policyholder purchases a term insurance policy, he can get an income tax deduction of up to Rs. 1.5 lakh on the premiums paid. The condition is that the sum assured must be a minimum of 10 times the annual premium paid for the term insurance policy. If this condition is not met, he cannot claim the deduction. Note that an individual or a Hindu Undivided Family (HUF) can claim this deduction only. 

Section 80D

Another section which dictates term insurance tax benefits is Section 80(D). In this, the policyholder can get term policy tax benefits under insurance policies related to health insurance. If the policyholder purchases a term insurance policy along with a critical illness rider or any other rider that is related to health, he can claim a deduction on the premium he pays. Individuals can claim a deduction of up to Rs. 25,000 and senior citizens can claim up to Rs. 50,000. This is provided to individuals and HUFs only. 

Section 10(10D)

According to this section of the Income Tax Act, 1961, the policyholder is exempted from paying tax on the maturity amount received. This holds when the sum assured is at least 10 times the annual premium he pays. Individuals and HUF taxpayers can both avail of this facility and enjoy term life insurance tax benefits. In case of the policyholder’s unfortunate death, the nominee will receive the death benefit which is completely exempt from tax. There is no limit on the tax benefit for the nominees.

Tax benefit from health insurance

Health insurance protects you from paying out-of-pocket for medical conditions and surgery expenses. It can put a serious dent in your savings when unexpected medical conditions are diagnosed. It is best to opt for a health insurance policy to stay safe in case you need surgery or you need immediate medical attention. Many types of health insurance policies exist such as family floater health insurance, individual health insurance, senior citizens health insurance, and critical illness health insurance. 

The policyholder can receive health insurance tax benefits as specified in Section 80D of the Income Tax Act, 1961. This is the only section that is related to the health insurance policy tax benefits and explains how the policyholder can get deductions on their health insurance policy. 

Section 80D

This section of the Income Tax Act, 1961 states that the policyholder can get a deduction on the premium he pays when he purchases health insurance plans. He can buy the policy for himself, his parents, his children, or his spouse. He can get a deduction of Rs. 25,000 when he purchases the policy for himself, his children, or his spouse. He can get an additional deduction of tax on health insurance premium of Rs. 25,000 when he purchases the plan for his parents.

Therefore, the policyholder can get a Mediclaim in income tax deduction of up to Rs. 50,000 if the policyholder is aged 60 or more. This applies to both types of policies; the one he buys for himself, his spouse, or his children, and the one he buys for his parents. This section specifies that HUFs and non-resident Indians (NRIs) can claim health insurance benefits on their income tax if they purchase the policies in India.

It is important to note that the policyholder can avail of a Mediclaim deduction if he pays through credit or debit cards, cheques or bank drafts. If the policyholder paid the premium using a cash mode of payment, he cannot avail of any Mediclaim deductions thereby losing out on saving on his income tax liability. He can also get riders he purchased with his current health insurance policy and avail tax benefits from the same for additional income tax reduction. This applies to when he buys critical illness coverage too. 

Preventive health check-ups are important for individuals of all ages as they ensure ailments are identified in their early stages thereby improving the chances of a full recovery. When the policyholder does not meet Mediclaim deduction limits, he can get a preventive health check-up allowance. Those people under 60 years can get an allowance of up to Rs. 5,000 while those above 60 years can get an allowance of up to Rs. 7,000. 

Key takeaways

The policyholder can enjoy a range of insurance tax benefits to get health insurance tax exemption, life insurance tax benefit, and term insurance benefits in income tax. This lowers the policyholder’s income tax liability while also providing financial protection to his loved ones in the case of death and disease. It is advised to thoroughly read the terms and conditions under which claims can be made and when the claims are considered invalid to avoid disappointment during the tax season. If you do not have insurance, you can get it any time you start earning a stable income.  

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