Tuesday, January 17, 2012

Do Insurance Policies Really Help Save Tax?



The title is misleading, isnt it? We all know that Insurance Policies help us save tax. You might be wondering, hey Anand, what silly question is this???

Well my dear readers, there is a purpose to this post. Lets take a look at the synopsis of an email I received from one of the readers of my blog a few days back.

Hi Anand,
I had taken a LIC Policy in 2011 in the name of my Minor Brother who is dependent on me. However, the finance department in my office refused to accept the premium paid against the policy for tax deductions under Sec 80C. Can they do that? Please help.

Regards,
Victor

So tell me, was the finance department correct in refusing the premium receipt submitted by Victor on a policy he had taken on his brothers name?

Unfortunately, the Finance Department was correct and Victor mis-understood the Indian Taxation Laws.

Now, go back and read the title again. Does it make sense?

The purpose of this post is to throw some light on the “*Conditions Apply“ aspects of Insurance Policies with respect to the Indian Income Tax Laws.

In my earlier post in “Insurance & Indian Income Tax“ we had taken a look at how Premium paid on insurance policies can provide tax benefits under section 80C. Unfortunately, the whole situation isnt all black and white. There are few catches on the tax benefits you can get from policy premium paid.They are:

1. Name of the Person on whom the Policy is Taken
2. % of Premium Amount that is Eligible for Tax Deduction
3. Mandatory Holding Period

Lets take a look at them one by one in detail.

Name of the Person on whom the Policy is Taken

As per the Indian IT Laws, Premium paid against Life Insurance Policies are eligible for tax deduction only if the policy is registered in the name of:
a. The Tax Assessee (You)
b. Spouse & Children (In case of Married People)
c. Parents (Only if both Mother & Father are Retired/Unemployed/Have No Income)

Premiums Paid in the below cases are not eligible:
a. For a Brother or Sister – Even if they are not earning any income
b. For Parents (If either the mother or the father is still earning)
c. For Uncles, Aunts, In-laws etc

As you can see from the above list, Mr. Victor did not know that premium paid on a policy taken on his Brothers name, eventhough the brother is a Minor and dependent on Victor, he is not eligible to claim tax deductions on that payment.

% of Premium Amount that is Eligible for Tax Deduction

You might be thinking, section 80C has an upper limit of 1 lakh. So, any insurance premium paid upto Rs. 1 lakh is eligible for Tax Deductions. Whats the big deal about it?

Did you really think that?

Unfortunately my friend, its not that simple. The actual premium paid is considered fully for tax exemption (with a higher limit of 1 lakh, of course) only if the amount does not exceed 20% of the Policy’s Sum Assured.

This is something, many of us do not know. In one of my earlier posts, I had written about Insurance Agents mis-selling policies. You may want to be cautious if an Insurance agent tells you something like below:

An Insurance Agent is telling his client that, he has this great One Time Premium policy, wherein if he pays 75000 this year, he will get 2 lakhs at the end of 5 years. Since he can use the full 75000 for tax rebate @ 30% tax rate, he is effectively paying only Rs. 52,500/- and getting 2 lakhs in 5 years. Which is 4 times the money invested.

You must remember that, if the Sum Assured (Maturiy Amount) is 2 lakhs then, the maximum premium you can pay and claim tax rebate in a single financial year is only 20% of it, which is Rs. 40,000/-. The remaining Rs. 35,000/- is not eligible for tax calculation purposes.

Curious Cat Kind of Question:
My Agent tells me that LIC declares a loyalty bonus for all policy holders when the policy matures. So, if i consider a nominal loyalty bonus addition to the policy maturity amount, my premium falls under the 20% slab. Can i claim the whole amount for tax rebate?

Answer: No. The IT Laws do not consider any loyalty bonus or any additional amounts your insurance company could pay you at maturity. Since such amounts are not guaranteed, the IT Laws only consider the policy maturity amount and nothing more.

Mandatory Holding Period

As per the Indian IT Laws, any Tax Payer, who claims tax deductions under Sec 80C using life insurance policies, is expected to pay his/her insurance premium for a minimum period of 2 full years. For a single premium policy if the contract is terminated within two years of the commencement of insurance then the benefit already taken would have to be reversed. The consequence of not fulfilling the holding period is that there is no benefit for the current year for the premium paid and all the previous benefits are reversed with the amounts being considered as income.

For ex: Lets say Mr. Sharma used his premium paid receipts to avail tax benefits in the financial year 2010-11 and for some reason, missed his premium payments in the whole of the year 2011, the IT Department has the right to revoke the tax benefits he claimed in the financial year 2010-11 and ask Mr. Sharma to pay the tax applicable on the deducted amount.

So, if you are someone who is in the habit of forgetting Insurance Payments, do remember that if you miss your payments and the policy lapses, you may end up paying extra taxes on the amounts you claimed tax rebate...

Curious Cat Kind of Question:
For Annual Premium Payment policies, if I pay 2 premiums (2 years) would that suffice?

Answer: No. Since the first premium is paid while taking the policy, you have to pay the annual premium atleast twice (two years) in order to satisfy the mandatory holding period. This means, you must pay a total of 3 premiums, the first while taking the policy and two more in the subsequent two years in order to avail tax benefits.

Since the Jan-March period of the year is considered the “Save Tax“ quarter where people scramble to invest money in tax saving instruments, it would be a nice idea to remember the above mentioned points while taking Insurance Policies that are aimed at saving tax.

Happy Insuring & Tax Saving!!!

1 comment:

  1. Life insurance acts as a great investment option. Though one may not benefit from it directly, he or she will at least be assured that the dependents will be able to live on with the death benefits. Tax exemption is one of the main advantages, that comes along with a life insurance policy. If everything goes on normal, the death benefits received by the beneficiary of the policy will be free from taxes. Anyway, as it has been pointed out, policy clauses can be misleading. Unless you’re an expert in the insurance industry, you should measure each of your steps before signing your insurance papers. And one other thing to be kept in mind is that, ‘Never should you trust your insurance agent blindly’. They might promise you a lot of things, to make you buy an insurance coverage through them, so that they might get their commission. But if you don’t stay on your own guard, you might be prey to the fraudsters or be led into buying unnecessary coverage.

    ReplyDelete

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