Prioritise policies with higher maturity for tax exemption
This approach will minimise your tax liability on traditional policies with lower maturity proceeds
A new circular issued by the income-tax (I-T)
department provides greater clarity on the taxability of non-unit-linked (basically,
traditional) life insurance policies. Prior to Budget 2023, a payout from any
life insurance policy (other than unit-linked insurance plans, or Ulips) was
exempt from taxation, provided a few specifications were met.
“According to section 10 (10D), amended in the
Finance Act of 2023, there is no tax exemption for life insurance policies
issued on or after April 1, 2023, if the premium exceeds Rs 5 lakh.” An
additional condition, which has been there for a long time, is that there is no
exemption if the premium exceeds 10 percent of the sum insured.
Plugging tax leakage
Under the old rules, the maturity benefits
enjoyed tax exemption irrespective of the premium amount. While the goal was to
promote insurance penetration, these police ended up becoming a tax-avoidance
tool for high-networth individuals (HNIs) who bought high-value policies with
hefty premiums. “Affluent individuals were drawn to these plans due to their guaranteed,
tax-free maturity benefits coupled with insurance coverage. Observing this, the
government introduced these amendments.”
Rules for multiple policies
If the aggregate premium of more than one
policy exceeds Rs 5 lakh, only the policies with a combined annual premium of
up Rs 5 lakh will be exempt. Investors can choose the policies whose proceeds
they want exempted. Narang clarifies that Goods and Services Tax (GST) applied
on the premiums will not count towards the Rs 5 lakh limit.
Suppose that a new policy was purchased, on April
1, 2028, after the premium-paying term of an earlier policy had ended. The
annual premium of two policies exceeds Rs 5 lakh. Association of Registered
Investment Advisors (Aria): “The earlier policy may not have matured.
Nonetheless, the maturity benefits received from both will be exempt. The key
is that the annual premium paid on multiple policies should be exceeding Rs 5
lakh.”
Term polices don’t make any payout if the
insured survives the policy term. The premium of a term policy will not be
counted towards the Rs 5 lakh limit. Jain points out that any payout made to
the nominee upon the policyholder’s death continues to be tax-exempt. This is
regardless of the nature of the plan. How fill tax be calculated in the case of
policies where the payout is not exempt? “The premium paid can be deducted from
the maturity benefits. However, an indexation benefit is not available.” The
net amount shall be taxed as income from other sources.
“These revisions provide lucid directives for
claiming exemptions on eligible life insurance policies.”
HNIs to be impacted
The Rs 5lakh threshold is reasonably high, so
these changes will mostly affect HNIs. After April 1, 2023, taxpayers should be
mindful while investing in traditional policies for tax-free returns. “Make
sure you do not cross the Rs 5 lakh premium threshold.” He adds that where the
proceeds become taxable, the post-tax returns are likely to be sub-optimal. The
pre-tax returns from these plans anyway don’t exceed 4-6 percent. Taxation at
slab rate will make their post-tax returns even less attractive.
If you are planning to change your payment
frequency, think again. “If an individual’s alters her premium payment
frequency within the policy term, such as shifting from annual to semi-annual
or quarterly payment, resulting in the premium exceeding Rs 5 lakh, the
maturity of the policy will become taxable.”
Experts have always warned against mixing
insurance and investment. “Buy term insurance for protection. ”For investment,
go with products like fixed deposits, mutual fund, etc. For Ulips, the
government had imposed a cap on the premium even earlier. So, ensure that for
Ulips purchased on after February 1, 2021, the aggregate annual premium does
not exceed Rs 2.5 lakh.
Offer the traditional policies with higher
maturity proceeds first for exemption and let the policies with lower maturity
proceeds be subject to taxation.
STRATEGY FOR THOSE HOLDING MULTIPLE POLICIES
If the aggregate premium of multiple policies
exceeds Rs 5 lakh, only the policies with annual premium up to Rs 5 lakh will
be tax-exempt (investor can choose the policies she wants exempted).
Suppose that a policyholder has five policies
with annual premium of Rs 1 lakh (A), Rs 1.5 lakh (B), Rs 2 lakh (C), Rs 3 lakh
(D) and Rs 4.75 lakh (E).
In this case, the investor may choose policy E
for exemption (as premium is below Rs 5 lakh).
However, she could select policies C and D for
exemption, as the maturity benefit from them is likely to be higher than from
E.
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