Tax and Income from Life Insurance

Life insurance is a part of one’s investment portfolio and is therefore considered to be an asset. It can be used as a handy tax planning tool. In fact, any amount received by the policy holder from the insurance company, including any bonus on the policy, is totally exempt from being taxed. There are a few exceptions, though:

A) Where the policy holder takes the policy for a disabled dependent and this dependent dies before the policy holder does; and the policy holder receives the amount from the insurance company.

B) Any amount received under Key Man Insurance Policy.

C) Where the Life Insurance Policy is issued on or after 01.04.2003 and the premium payable on the policy in any year is more than 20% of the capital sum assured in the policy, any amount received by the policy holder under such a policy (including bonus) is not exempt; e.g. Bima Nivesh, Jeevan Dhara Plans.

In all the above situations, receipts from life insurance are taxable. But if the receipts are in the form of claims due to the policy holder’s death, then these are not taxable. Also, if the policy was issued before 01.04.2003 in the last scenario above, the receipts from the policy will not be taxable.

Tax on receipts from a Life Insurance Policy is levied not on the entire amount, but only on the difference between the total amounts paid over the years as indexed (i.e. the total cost of the policy); and the receipts from the policy. This is because a life insurance policy is an asset, as we saw earlier. So tax is levied only on the capital gain and not on the entire income.