Tax Benefits under Single Premium Life Insurance Policy!

A life insurance policy is a legal contract between the insurance company and the person insured. There is a consideration that needs to be paid for coming into a contract under the Indian Contract Act. In life insurance contracts, the premium is the consideration that the policyholder has to pay to the insurance companies. In return, insurance companies assure to pay the defined sum in case of the claim event (either death or maturity).

Many of us must know that till the time you are associated with the insurance company you need to pay the premiums typically known as regular premium pay life insurance plans. For regular pay premium payment term is equal to the policy term. But there are life insurance plans where a policyholder can pay the premium at one go only for the entire insurance policy term known as Single Premium Life Insurance plans.

Apart from regular pay and single pay life insurance policies, there is another category of premium payment known as “ limited pay life insurance plans” where the policyholder has to pay the premium for a limited tenure like 5 years or 10 years or as mentioned in the insurance plan.

Premiums Payment options are of different types which are:

• • Regular Premium- Premium payment term is equal to the policy term
  • Single Premium – One time premium payment at the inception
  • Limited Pay – Premium payment term is for specified years less than the policy term

Tax Benefits under Single Pay Life Insurance Policies

Premium payment for the life insurance policy qualify for the tax deduction under section 80C of the Income Tax Act up to Rs 1.5 Lakhs every financial year and maturity benefits are tax free under Section 10 (10D). But what about the Single Pay Life Insurance Policies and what kind of tax benefits will it offer?

Singe Pay Life Insurance Policy being a kind of a life insurance policy too qualifies for tax benefits, both under Section 80C (at the time of investment) and under Section 10 (10D) for making the maturity proceeds tax-free.

Not all Single Pay Life Insurance Policies will offer you similar tax benefits as conferred under a regular pay life insurance plans. So one needs to be careful about certain conditions under which best Single Pay Premium Policies can avail the tax benefits.

Let us have a look at certain conditions which will qualify Single Premium Life Insurance Policies to be qualified for Tax Benefits under Section 80 C and Section10 (10D):. 

Conditions for Tax Exemption on Maturity Proceeds under Section 10 (10D)

For all life insurance policies issued on or after April 1, 2012, the tax exemption is available only if the premium amount in any financial year does not exceed 10% of the actual capital sum assured. This applies to all single life insurance policies as well.

The maturity proceeds from the single premium life insurance policy will be tax-free only if the minimum sum assured throughout the policy term remains at least 10 times the single premium paid. So if the sum assured on single premium life insurance policies is 1.25 times the premium amount, then the maturity proceeds will be taxable.”

Example: The single premium life insurance sum assured is Rs 1 Lakh and the premium is Rs 10,000. In this case sum assured is at least 10 times the premium amount. So, the maturity proceeds will be tax free under Section 10 (10D). But if the sum assured is Rs 90,000 or less than Rs 1 Lakh, it will lose the tax benefits and the maturity proceeds will not be tax free.

 Bottom Line: Ensure that the sum assured is at least 10 times the premium amount under a single premium life insurance policy to get the tax free maturity proceeds. 

If the condition is not met, of sum assured being less than 10 times of the premium is not met, then the entire maturity proceeds are fully taxable in the year of receipt. Such proceeds have to be shown as income while filing one’s income tax return. However, in case of death proceeds, the death claim proceeds are completely tax free irrespective of the level of premium. Also, the insurance company shall deduct tax at source (TDS) on such payments. As per Section 194DA of the Income Tax Act, 1961, any sum received by an insured Indian resident from an insurance company under a life insurance policy shall be subject to TDS of 1% if the maturity proceed is not exempted under Section 10(10D), i.e., on policies where the sum assured is less than 10 times the premium amount.

What Insurers offer as Sum Assured under Single Premium Life Insurance Policy?

Insurance companies determine the minimum and the maximum sum assured limits under the single premium life insurance policy. Usually, the minimum sum assured is 1.25 times the single premium, or even 1.10 times the single premium. The maximum sum assured which can be offered is 10 times the single premium. But it is typically for lower age categories. For the age categories above 35 or 45, the sum assured offering is the maximum of 1.25 or 1.10 times the single premium amount. So, if you choose to go with the maximum cover of 10 times, the tax benefit is lost.

Policyholder’s Dilemma

Policyholders usually opt for a lower sum assured because higher the sum assured, higher will be the mortality charge (cost of offering death benefit). So, in investment plans like unit inked insurance plan (ULIP) higher sum assured will attract a higher mortality charge and the lesser amount will be invested to attain potential returns. Even though the mortality charges in a policy with 10 times the sum assured will be more than a policy with 1.25 times the sum assured, remember, the tax benefits are lost in opting for the latter. So to avail tax free maturity proceeds the condition of 10 times the sum assured of a single premium must be availed.

Tax Benefit under Section 80 C for the Single Premium Life Insurance Policy

It is a known fact that the premium paid towards life insurance policies is eligible for deduction under Section 80C, up to a maximum of Rs 1.5 lakh a year. The gross total income gets reduced by the premium amount and, thus, reduces the tax liability further.

The condition says, for all the life insurance policy issued on or after April 1, 2012, if the premium paid exceeds, 10 % of the sum assured, then the tax deduction (from the gross total income) will be obtainable to the extent of 10% of the sum assured only. The premium paid in excess of this amount cannot be claimed as deduction.Single premium life insurance policies should not exceed 10% of the sum assured or the sum assured should be at least 10 times the single premium paid. It is important to note that the benefit under section 80 C is eligible only for the financial year when the premium is being paid for a one time payment policy.

Example, if you buy a single premium life insurance policy:

Case 1: Assuming Single Premium is Rs 1 lakh and the Sum Assured is of Rs 10 Lakh. Here the benefit received under section 80 C is max up to Rs 1 Lakh (10% of the sum assured). So, you can claim up to Rs 1 lakh for your single pay life insurance policy. However, there is still a scope of an additional 50,000 which can be claimed under section 80 C which can be claimed by investing it in another life insurance policy or other specified investment options under Section 80 C.

Case 2: Assuming Single premium is  Rs 2 lakh and the Sum Assured bought is Rs 20 lakh (10 times of the single pay amount), the benefit under section 80 C is maximum up to 10 times of the sum assured which comes out to be 2 Lakh (10% of the sum assured). But the maximum ceiling limit is Rs 1.5 Lakhs only under section 80 C. So, the tax deduction will be up to Rs 1.5 Lakhs only in this case.

Case 3: Assuming Single premium is Rs 2 lakh and the Sum Assured is Rs 2.5 lakh (less than 10 times the single pay premium), the deduction under Section 80C will be restricted to Rs 25,000 (10% of the sum assured).However, the upper limit is Rs 1.5 Lakhs under section 80 C to claim tax deductions. So, this way by opting lesser sum assured, policyholders’ restrict their tax benefits.

Tax Implications in case of Surrendering the Single Pay Life Insurance Policy

The minimum stay period for a single pay policy is generally for 2 years. If the single pay life insurance policy is surrendered within two years since inception, the tax deduction allowed in the past under Section 80C will be considered as income of the policyholder in the year of surrender and applicable tax will be levied.

Conclusion

So in a nutshell, it is important to make sure that you buy the right amount of sum assured or life cover under a life insurance policy with a single premium to take tax benefits. However, the income tax rules prevailing at the time of maturity will be applicable. But one needs to plan as per the current scenario. So, to avail tax benefits under single premium life insurance policy, one needs to keep in mind the above mentioned conditions to avail tax benefits under section 80 C and 10(10D).