New Norms For Tax-Free Receipt From Insurance Policies Explained

There has been a change in Section 10 (10D) of the Income Tax Act, which deals with the receipt of tax-free amounts from life insurance policies.

In recent times, there have been several exclusions that have been added to this section and the most recent one says that if the premium paid during the year on such life insurance policies exceeds Rs 5 lakh, then the amount would be taxable. The tax department has now come out with an explanatory statement on this. Here are some of the main points that individuals should keep in mind while they are looking at tax-free payouts from life insurance policies.

The most important point for the applicability of the new rules is that the life insurance policy should have been issued on or after April 1, 2023. This clearly shows that all the older policies that were issued before the start of financial year 2024 are not covered under this change and they will continue to enjoy the benefit of the tax-free receipt if they meet the other conditions that are applicable.

The other factor that also needs to be taken into consideration is that the wordings clearly state that in case any amount is received on the death of the policyholder, then the amount that is received would remain tax-free.

It could be that the policy premium was violating the Rs 5 lakh and if the amount would have been received on maturity, it would have been taxable, but this will have no impact if the situation changes. Policies also have a life-cover element, so if there is any amount received on death, this would not be taxable.

The current change that has been made is for life insurance policies that exclude the unit linked insurance policies. This is because there is another condition in the same section of the Income Tax Act that was introduced earlier that said receipts on ULIP policies where premium paid in excess of Rs 2.5 lakh paid in a year is taxable.

Within the life insurance policies bouquet, there is an exemption for term policies too even if the premium paid in the year exceeds Rs 5 lakh. Term policies are those where the payout is only on the death of the individual during the policy term. They provide large amounts of cover for a comparatively lower premium as compared to other types of policies as they involve only mortality risk. The figure of the premium paid on term policies are also not to be counted to see which policies exceed the limit of Rs 5 lakh.

If an individual has a single life insurance policy, then the calculation is simple because they just need to see if the premium is less than Rs 5 lakh and if it is, then the receipt would be exempt from tax. However, if there are multiple policies with an individual, then they will be able to get the exemption on those policies where the aggregate premium is less than Rs 5 lakh.

For example, if a person has three policies on which they are paying Rs 3 lakh Rs 2 lakh and Rs 2 lakh as premium, then the exemption will be available for the first two policies where the total premium does not exceed Rs 5 lakh. The individual can choose from the various policies that they have to see which of them yield the best benefit when they look for which to include below the Rs 5 lakh limit.

Life Insurance Policies also have an impact in the form of goods and services tax that is levied on the premium that is paid by the policyholder. For the calculation of the Rs 5 lakh limit, the GST portion has to be excluded to see whether the policy premium is under the limit for the exemption. This is important because in some cases, the total payment might cross the Rs 5-lakh mark after the GST element is added to the actual premium.

Arnav Pandya is founder at Moneyeduschool

The views expressed here are those of the author and do not necessarily represent the views of BQ Prime or its editorial team