Take cover to cut tax

The tax-efficient nature of life insurance makes it an ideal vehicle to save income tax.

Print Edition: December 11, 2008

Life insurance is probably the least understood of all financial products. While the basic purpose of life insurance is to protect the dependants of the insured from financial loss in the event of his/her death, it is usually bought as a taxsaving tool.

Income tax comes into play at two points during the term of an insurance policy—at the time of buying a policy and when income is received from the policy. When you buy a life insurance policy, you are eligible for tax deduction under Section 80C. The premium paid gets deducted from your gross income while computing your tax liability for the year.

 Example (Rs)Your figures
Gross income6,00,000---
Tax-free limit1,80,000---
Insurance premium (Sec 80C)1,00,000---
Health plan premium (Sec 80D)30,000---
Taxable income2,90,000---
Tax liability46,000---
Education cess (3%)1,380---
Total tax liability47,380---
The calculation is for female taxpayers

However, there is a catch. This deduction is allowed only if the premium is up to 20% of the insurance cover. For instance, if you take an insurance cover of Rs 1 lakh and pay an annual premium of Rs 25,000, the deduction is valid for only Rs 20,000 (20% of Rs 1 lakh). The tax deduction also requires one to be bound to the policy for at least three years to get the tax benefit. If a policy is terminated within three years, the tax deduction is withdrawn and the amount is treated as income and taxed.

There are other tax rules that you should be aware of, especially if you take a single premium plan. If the insurance contract is terminated within two years in case of a single premium policy, the tax deduction allowed earlier is taxable as income. The tax deduction on premium contributions is also valid for pension plans, which have two parts—accumulation and pay-off. The premiums paid during accumulation get benefits under Section 80C.

There are more tax deductions in insurance. If you have a health insurance policy, the deduction under Section 80D is up to Rs 15,000 a year, and up to Rs 20,000 in case of senior citizens. The deduction is also available on the add-on health riders.

Lastly, any sum received by a policyholder on maturity or by his nominees as death benefit is tax-free under Section 10(10D). Bonuses or profits received are also exempt from tax. The first 33% of the corpus of a pension plan is tax-free. The balance is treated as income and taxed.

» Premiums paid for life insurance policies are eligible for deduction under Section 80C.
» This deduction is available only if the premium is up to 20% of the insurance cover.
» Any sum received on maturity of policy or on death of the insured person is tax-free. So are the bonuses.
» Health plan premiums get deduction of up to Rs 15,000 a year under Section 80D.

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