Do Beneficiaries Have to Pay Taxes on Life Insurance?

A life insurance policy is an efficient tool to take care of your loved ones in your absence. It provides a death benefit to your dependents if anything unfortunate happens to you and acts as a financial cushion. In term insurance, the death benefit is provided only when the policyholder dies during the policy tenure.

But, other types of life insurance offer maturity benefits too on surviving the policy term. Life insurance also helps in tax savings where premiums up to ₹1.5 lakhs are tax-exempt under Section 80C of the Income Tax Act, 1961. But you might wonder if you or the beneficiary of your life insurance has to pay taxes on the maturity or death benefit. Find out here.

Taxability on Life Insurance Plans

According to Section 10(10D) of the Income Tax Act, 1961, the life insurance proceeds paid on the policy’s maturity/surrender or death of the insured are tax-free. While there is no upper limit to the tax exemption under Section 10D, the payouts are subject to taxation under certain conditions in the hands of the policyholder:

• If the policy is issued after 1.4. 2003 but before 31.3. 2012 where the premium per annum exceeds 20 percent of the sum assured, the policy benefits are taxable. It is to be noted that the sum assured does not include the bonus amount or the premium that the insurance provider has to return to the policyholder.
• If the policy is issued after 1.4.2012, where the premium paid annually exceeds 10 percent of the assured sum, the policy proceeds will be taxable.
• If the policy is issued after 1.4. 2013 and the policyholder suffers from a severe disability or critical illness, then the limit is increased to 15 percent of the sum assured. But the disability or critical illness must come under relevant sections of the Income Tax Act,1961.
• If the premium in any year exceeds the prescribed percentage of the sum assured, the entire payout will be taxed in the year it is received. But, if the policyholder dies and the proceeds go to the beneficiaries, no tax is applied, even if the premium in any year exceeds the prescribed percentage.

When Do Beneficiaries Have To Pay Taxes On Life Insurance Payouts?

Usually, the beneficiary doesn’t have to pay taxes on life insurance payouts. But many people believe that life insurance proceeds are tax-free in the hands of the nominees in every situation. The situations when the beneficiary is required to pay taxes on the life insurance payouts are as follows:

• Accrual of interest

  When a policyholder specifies not to pay the death benefit to the beneficiary immediately after his/her death, the insurer keeps the insurance payout on which interest accumulates. When the sum assured is released to the beneficiary along with the interest payment, the receiver has to pay taxes on the accumulated interest.

• The estate becomes the beneficiary

  If the policyholder names an estate or doesn’t mention any beneficiary in the life insurance policy, the death benefit becomes part of the policyholder’s estate. Also, if the primary beneficiary dies with no contingent beneficiary, the insurance payout is considered the policyholder’s estate. In this situation, the sum assured is taxed like an estate or inheritance. Thus, to avoid payment of taxes, the policyholder must name a beneficiary and a contingent beneficiary.

To Sum It Up

Knowing the tax provisions of any financial product is crucial before moving ahead. No doubt, life insurance plans help you in tax-saving, but you must know when the policy proceeds are taxed and when not to make an informed decision. So, ensure to read all the terms and conditions of the policy carefully to know about tax deductions. You must also name at least one primary beneficiary and one contingent beneficiary to ensure tax-free death benefits.