New Norms Decoded: Tax-Free Receipt from Insurance Policies

A recent change has been introduced in Section 10 (10D) of the Income Tax Act (ITA), 1961, which is associated with tax-free payouts from life insurance policies.

As per this, if the premium paid during the year on such life insurance policies is over Rs 5 lakh, the amount would fall under the tax ambit. The Income Tax (IT) department has issued a suitable explanatory statement in this regard.

A few of the key points related to tax-free payouts from life insurance policies include:

Issue date: When it comes to new rules’ applicability, the life insurance policy must have been issued on or after April 1, 2023. This means that all the older policies issued before the beginning of the Financial Year (FY) 2023-2024 do not fall in the ambit of the new change. Such policies will continue to benefit from the tax-free receipt provided they address the other applicable conditions.

Non-applicable on death: In a scenario where any amount of money is received in the eventuality of the death of the policyholder, then such an amount will remain tax-free. There may be a possibility that the policy premium was breaching the Rs 5 lakh threshold, and if the amount would have been received on maturity, it would have been taxable. However, this will have no impact in case the situation changes. Generally, policies tend to have a life-cover element; if any amount is received on death, this will not fall under the tax ambit.

Exclusion of term policies: The current change applies to life insurance policies and does not include Unit Linked Insurance Policies (ULIPs). This is due to another condition in the same section of the ITA, 1961, which was introduced earlier. As per this, receipts on ULIPs in which the premium paid in a year is above Rs 2.5 lakh, then it is taxable.

Amidst the categories of life insurance policies, there is an exemption for term policies, despite the premium being paid in a year is more than Rs 5 lakh. Term policies are those where the payout is initiated in the eventuality of the individual’s death during the policy term. They provide significant amounts of cover for a relatively lower premium vis-a-vis other types of policies as they involve just mortality risk. The premium paid on term policies is also not to be counted to witness which policies exceed the threshold of Rs 5 lakh.

Calculation of multiple policies: In case a policyholder has a single life insurance policy, the calculation is relatively simple. They merely need to check if the premium is less than Rs 5 lakh, and in case it is, the receipt would not invite any tax.

In case an insured individual holds multiple policies, they can gain exemption on those policies in which the aggregate premium is lower than Rs 5 lakh.

Non-inclusion of Goods and Services Tax (GST): Insurance policies also experience an impact in the form of GST, which is applicable to the premium that a policyholder pays.

In order to calculate the Rs 5 lakh threshold, the GST part has to be excluded to check that the policy premium is within the limit for the exemption. There is a possibility in some cases that the total payment is likely to exceed the Rs 5 lakh threshold after the GST component is added to the actual premium amount.