Life insurance, as we know, acts as a risk transfer mechanism - a contract between you and the insurance company where you pay premium regularly & the insurance company assures death benefits to your loved ones on your demise. So far so good. The problem arises when life insurance companies sell life insurance policies as investment products that create wealth for you. The insurance lobby has managed to extract tax benefits from the government and dangle them as bait before gullible buyers.
The way this market has evolved has turned it into a treacherous path to picking the right policy/plan, shrouded in questions such as - What type of life insurance policies should you buy? How much should be the ideal life cover that you must have? What are the many tax benefits that policies offer? Should tax benefits be the only reason for buying LI policies?
Let’s get some answers.
The pick
The life insurance (LI) industry & the ecosystem peddle all types of policies. The ones offering purely death benefits are called term plans. Then there are bunch of them that offer both death as well as maturity benefits like endowment plans, child plans, money-back plans, retirement plans, Unit-linked insurance plans (ULIPs) & sold as investment products.
This begs the question-What should you pick from this bouquet of products? Only term plans- policies that provide only death benefits. Period. Term plans are the cheapest of all policies in terms of premium paid vis-à-vis the sum assured. Every other policy is a waste of money.
The ideal cover
The cover or sum assured should be at least 15 times your annual income or earnings. Why 15 times you may ask? Assuming that an individual’s annual income is Rs 10 lakhs, he must have LI policies with a sum assured of Rs 1.5 crore. In the event of his death, his family would keep the insurance proceeds as a fixed deposit. The interest income of Rs 10.50 lakhs, assuming 7% interest, would compensate for the financial loss for the family & take care of their financial needs including clearing of debts.
The incidence of tax
The premium you pay on life insurance policies can be claimed as a deduction under Sec 80C of the Income Tax (I-T) Act. Maturity proceeds are exempt from tax under Sec 10 (10D) of I-T Act. That said, you should buy insurance only to protect your family from financial loss and not to reduce your tax liability or for the tax benefits they offer.
The Union Budget presented in February wiped the tax-saving sheen off all LI policies. Starting April 2023, under the default new tax regime, all maturity amounts are taxable if the premium paid in a year is above Rs 5 lakh for traditional plans and above Rs 2.5 lakh for ULIPs.
But those who have stuck with the old regime, the incidence of tax is as follows:
The deduction under Section 80 of the I-T Act is restricted to 20% of the capital sum assured, for policies taken prior to March 31, 2012 and 10% for those picked after April 1, 2012.
No deduction on premiums is available for NRIs, irrespective of when the policy was taken.
Maturity proceeds under policies not exempted under Section 10 (10D) above Rs 1 lakh are also subject to TDS (Tax deducted at source). While making the payment on maturity, the insurance company will deduct TDS of 5%. TDS will be on the net proceeds i.e the difference between the total premium paid & maturity amount received. For example, if the total premium paid is Rs 1 lakh & maturity proceeds are Rs 1.80 lakhs, TDS will be deducted on Rs 80,000.