Be aware of tax unfriendly insurance policies!

Tax Deduction at Source (TDS) on interest on Fixed Deposits and Recurring Deposits of banks have caught many savers with surprises. While buying Life Insurance, we are advised that premium payment upto Rs1.50 lakhs are tax deductible under section 80C and maturity proceeds are tax free under 10(10D). But it is not so always! Many insurance products do not qualify for full tax deduction and maturity not fully tax-free. The current low return on Insurance is further impacted by incidence of tax.

 TDS on Life Insurance Proceeds

Insurance products tend to give you a deduction of up to Rs1.5 lakhs from your taxable income under Section 80C. Effective April 2012, the sum assured should be at least 10 times the annualized premiums for life insurance policies to enjoy this tax benefits under Section 80C and on maturity proceeds under Section 10 (10D). Numerous life insurance products are available in the market that do not qualify for full tax savings on entry and will have no tax exemption on maturity. The new section 194DA of the Income Tax Act, 1961, that took effect on 1 October 2014, envisages TDS on life insurance policy payouts which are not exempt under Section 10(10D) and total amount paid to a policyholder towards non-exempt policies that exceeds Rs1 lakh in a financial year, would attract a 2% TDS (tax deduction at source) on the maturity, surrender or partial withdrawal amount of life insurance policy. If you are buying a life insurance product, which does not qualify tax-free returns, this may be an absolute disaster for your investment.

TDS taxes on Single Premium Products

Some investors are putting lakhs in single-premium products under the impression that they can earn tax-free returns. But they would be getting a bigger shock to know that product does not qualify for tax-free returns under Section 10(10D). IRDA guidelines allow single-premium product to offer minimum death benefit of 1.25 times of single premium and for those above 45 years of age 1.1 times. If you are above 45 and not healthy, the situation may be worse as your insurance company can load high mortality charges. Then your sum assured may not be 10 times the premium and, therefore, not tax exempt. The higher the age, the higher will be the loading in case of health issues due to higher risk for the insurer. Moreover, those living in rural and small towns will be severely affected by the new provisions, in case they do not have PAN cards. They will end up with 20% TDS instead of 2%.

 Taxing due to Not to Pay Minimum Premiums

Suppose you had bought a regular premium policy and stopped paying after the first premium, since there will be no TDS; but you will still be taxed due to discontinuation of premium by reversing the 80C tax benefit which you had availed. You should pay minimum of two premiums for life insurance policy to avoid this reversal. Taxation is also applicable for single-premium policy, if you terminate it within two years after the commencement date. The same holds true for ULIP (unit-linked insurance policy) plans which they need to pay minimum five ULIP premiums, to avoid this tax anomaly. The worst part is that insurers and agents do not explain these tax implications while selling the product.

Pension brings Tax Tension

Do you know that pension plans from life insurance are the worst financial products with respect to return as well as taxation point of view?  If you surrender a pension product anytime before maturity, you will have to give back the tax deduction you had claimed under Section 80CCC. The surrender value has also to be added to your income and taxed as per your slab in the year of surrender. While tax benefits are reversed on surrender, annuity is taxed whether TDS is cut or not.  If you let the pension product mature, one third of the corpus can be taken out as tax free; the remaining has to be invested in an annuity product sold by the insurance company. An annuity policy will give you an average of 7% per annum returns for lifetime. Annuity is also taxable. If you do not want to invest in annuity, two-thirds of the pension corpus will be taxable.


When buying financial products, we should evaluate the impact of taxation besides impact of inflation on returns on investment. Further we get carried away by nomenclature of child plans or pension plans. It is better to buy simple insurance term plan and   invest balance of the premium in mutual funds factoring the risk appetite and goal horizon. By this, you will gain both in higher sum assured and return. You need not worry about different interpretations of taxation of insurance products and  a nasty taxation shock when the policy matures.

Last modified on Saturday, 24 December 2016 06:26

Prakash Praharaj

Shri Prakash Praharaj has a passion for excellence. He has been awarded two gold medals for securing top positions both in Graduation and Post Graduation in Commerce. He is an MBA with specialization in Finance and marketing. He has been awarded Diploma in Treasury, Investment and Risk Management besides CAIIB from the Indian Institute of Bankers. He is a Certified Financial Planner from the Financial Planning standards Board, India (FPSB), affiliated to FPSB, Denver, USA and Certified Personal Financial Adviser from NISM. He is also a SEBI registered Investment Adviser vide Reg. no. INA 000000045 dated 2nd August 2013.His book "Your Every day guide to Personal Finance and Insurance" has been published by CNBC TV 18 in August 2015.


  • Subhra

    posted by Subhra

    Thursday, 18 August 2016 07:24

    Useful one

  • Kapil

    posted by Kapil

    Thursday, 18 August 2016 07:22

    very much imp to remember while investing.. I ll share this with my friends...Thank you.

  • Shruti

    posted by Shruti

    Thursday, 18 August 2016 06:38

    Very Informative!

  • Durga

    posted by Durga

    Thursday, 21 July 2016 05:36

    Good article!


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