Budget 2019 tweaks taxes on insurance maturity proceeds

Life insurance is a popular product amongst Indians. But a lot of taxpayers do not understand how receipts after the maturity of a life insurance policy are taxed. TDS (tax deducted at source) also comes into play in cases where receipts are Rs 1 lakh or more. TDS of 1 per cent is deducted by the insurance company before a payment is made. In the 2019 Budget, the government has made some changes to the TDS rate on proceeds from a life insurance policy and to the amount on which TDS is deducted. These aspects need to be understood in detail.

Maturity proceeds taxed

Receipts from life insurance policies are taxable if the premium paid exceeds 10 per cent of the sum assured. This is applicable to policies taken after April 1, 2012. For policies taken on or before March 31, 2012, the premium paid should be less than 20 per cent of the sum assured. Where the premium exceeds 20 per cent of the sum assured for a policy (taken on or before March 31, 2012), the maturity receipts will be taxable.

Therefore, maturity receipts of a life insurance policy may or may not be taxable, depending upon whether the premium paid meets the criteria mentioned above. If the proceeds from a life insurance policy are Rs 1 lakh or more, TDS of 1 per cent is deducted by the insurance company before making a payment. The pre-condition for deducting TDS is that the receipts must be both taxable and the payment should be Rs 1 lakh or more. Do note that Rs 1lakh is the threshold for applicability of TDS; but receipts may still be taxable where proceeds are less than Rs 1 lakh. Interestingly, the entire maturity amount is not taxable for a policyholder; only the net maturity proceeds are taxable. Receipts from a life insurance policy paid on the death of a subscriber are exempt from tax.

Understanding TDS

Let’s understand this in detail with an example. Suppose you bought a policy on May 1, 2013 and paid a premium of Rs 18,000 with a maturity value of Rs 1.02 lakh. Now, 10 per cent of the sum assured works out to Rs 10,200. Here the premium paid exceeds 10 per cent of sum assured; therefore, your maturity receipts shall be taxable. If receipts are taxable and are Rs 1 lakh or more, TDS is deducted by the insurance company before releasing the payment. The TDS rate is 1 per cent.

Let’s understand how tax is calculated. Suppose the premium is paid for 5 years and the net proceeds are: Rs 1,02,000 - (Rs 18,000 x5 years) = 12,000. Tax has to be paid on Rs 12,000 according to the income tax slab applicable to the taxpayer. Assuming that the taxpayer is in the 5 per cent tax bracket, tax to be paid on the net proceeds works out to Rs 600 (Rs 12,000 x 5 per cent). But 1 per cent TDS is deducted on Rs 1,02,000 = Rs 1,020. Notice that while the tax payable is Rs 600, a TDS of Rs 1,020 has been deducted. This caused hardship to taxpayers and to the department as well. It lead to difficulty in declaring and reconciling the income portion. Form 26AS would reflect the full redemption amount on which TDS is deducted and taxpayers have to declare and pay tax only on the income portion (explained above) in their return.

To remove this anomaly, the government has amended TDS rules on receipts from life insurance policies. Two changes have been made: first, the rate of TDS shall be 5 per cent. Second, TDS shall be deducted on the ‘income’ portion and not on the entire amount.

Now let’s look at the same example as above. TDS shall be deducted at 5 per cent on the income of Rs 12,000 and it works out to Rs 600, which is the same amount of tax required to be paid by the policyholder. Therefore, the policyholder will report an income of Rs 12,000 in his/her income tax return and an appropriate TDS would have been deducted on it. The form 26AS would indicate an income of Rs 12,000. Therefore, the income and the TDS in the ITR (income tax return) will match with the income and TDS in form 26AS.

This new rate of TDS and its calculation on only the income portion are applicable from September 1, 2019. Any proceeds received before this date will continue to be taxed as they were earlier.

(The writer is Founder and CEO, www.cleartax.in)