IT: Conditions attached with the LIC premium deduction under Section 80C

The Income Tax Act provides tax benefits if you pay the premium of a life insurance policy or a Unit Linked Insurance Plan (ULIP). It also provides tax exemption for maturity proceeds received from a life insurance or ULIP plan. Let us understand the law in detail.

Tax benefit in respect of premium paid for life insurance policies

Section 80C of the Income Tax Act allows an individual and a Hindu Undivided Family (HUF) to claim a deduction of Rs.1.50 lakh on certain eligible expenditures and investments. One of the items is the premium paid for a life insurance policy. 

The deduction is not product-specific, and you can claim it for premiums paid on term plans and for a product like ULIPs as well. Individuals can take the tax benefit if they pay a premium for the life insurance of self, spouse or any of their children. The deduction is not available if the life insurance premium is paid for parents, even if they are financially dependent on the taxpayer. A HUF can claim the deduction for the premium paid for policies taken on the life of any HUF member.

What are the conditions to avail of the deduction?

Annual premium to not exceed a certain limit

To claim the deduction, the annual premium amount should not exceed 10% of the sum assured for the policy issued after 1st April 2012. For the policies issued before 1st April 2012, the premium paid should not exceed 20% of the sum assured to claim this deduction. However, note that for a policy issued after 1st April 2013, which covers the life of an individual with a disease referred to under Section 80DDB or a disability referred to under Section 80U, the premium amount should not exceed 15% of the sum assured to claim the deduction under Section 80C.

Reversal of deductions

If you have claimed tax benefit on the life insurance policy, the policy needs to be kept active for two years. If the policy lapses within two years, the deductions allowed in earlier years are reversed and added back to the year’s income in which the policy lapsed. 

Tax treatment of money received from an insurance company

When the premium paid on the policy does not exceed 10% of the sum assured for life insurance policies issued after 1st April 2012 and 20% of sum assured for life insurance policies issued before 1st April 2012– any amount received on maturity or such policy or amount received as a bonus is fully exempt from tax under Section 10(10D). Also covered here are policies taken after 1st April 2013, on the life of a person with a disability or a disease specified under Sections 80U and 80DDB, respectively, where the amount received on maturity is tax-free provided the premium paid not to exceed 15% of the sum assured.

Where the premium amount paid is more than 10%, 15%, or 20% of the sum assured, as the case may be, the maturity proceeds shall be fully taxable under the heading “Income from other sources”.

Tax treatment of money received from ULIP

Additionally, the returns out of the ULIPs on maturity are exempt from income tax under Section 10(10D) of the Income Tax Act. However, any return on the ULIP investment, where the annual premium is above Rs 2.5 lakh a year, is taxable as per the new amendment in Budget 2021. The taxability will depend upon the fund’s exposure in equity or debt. Suppose the funds have more than 65% investment in equity instruments. In that case, the tax will be calculated as per taxation of equity mutual funds, i.e. the gains above Rs 100,000 shall be taxable at the rate of 10% without indexation. Otherwise, the tax calculation will work like debt funds. The tax rates will depend upon the holding period, i.e., they are chargeable to tax at slab rate if held for a period less than 36 months and at the rate of 20% with indexation if held for 36 months or more.

TDS on maturity proceeds of the policy

From October 2014, if the maturity amount received from a life insurance policy is more than Rs 1,00,000 on policies not covered under an exemption under Section 10(10D), the insurer has to deduct TDS at 1% before making payment. The insurer shall also deduct TDS on bonus payments. However, if the maturity proceeds are less than Rs 1,00,000, no TDS shall be deducted, but the amount received shall be fully taxable in the taxpayer’s hands. You can claim credit for the TDS deducted from your income tax return. 

For any clarifications/feedback on the topic, please contact the writer at namita.shah@cleartax.in