Guidelines issued by CBDT for taxing the income from life insurance policies with annual premium exceeding Rs 5 lakh – The Tax Talk

Guidelines issued by CBDT for taxing the income from life insurance policies with annual premium exceeding Rs 5 lakh

Earlier, any amount received on maturity of life insurance policy was totally exempt from tax. The tax free label of life insurance policy has been shrinking since few years. Finance Act-2023 has made the amount received on maturity of life insurance policies taxable if the premium or aggregate premium of such policies exceeds Rs. 5 Lakh. Taxpayers may recall that the Unit Linked Insurance Plan (ULIP) policy is already brought in the tax net if the annual premium on policies exceeds Rs. 2.50 Lakh.

Recently, the Central Board of Direct Taxes (CBDT) on 16.08.2023 has issued the guidelines on taxation of maturity amount of life insurance policies (Non-Ulip) wherein annual premium exceeds Rs 5 lakh.  The guidelines provide the rule of taxation on amount received at the time of maturity of the life insurance policies.

Taxation of the maturity proceeds from Life Insurance Policies is now as under:

1. ULIP Policies:
   a) Amount received at the time of maturity of ULIP issued on or after 01.02.2021 shall be taxable if the amount of premium payable in any of the previous years during the term of such policy exceeds Rs 2,50,000/-.
   b) If the premium is payable for more than one ULIPs issued on or after the 01.02.2021, the exemption under the said clause shall be available only with respect to such policies where the aggregate premium does not exceed Rs 2,50,000/- for any of the previous years during the term of any of the policy. Circular No 02 of 2022 dated 19.01.2022 was issued to explain how the exemption is to be calculated when there is more than one policy.
2. Non-ULIP Policies:
   Though ULIP policies were made taxable in 2021, other policies were enjoying the tax exemption till now. By the Finance Act-2023, the non-ULIP are also made taxable. Now, any amount received on maturity of insurance policies (other than ULIP) issued on or after 01.04.2023 having premium or aggregate of premium above Rs 5,00,000/- in a year will be taxable. This income shall be taxable under the head “Income from Other Sources”. Deduction shall be allowed for premium paid, if such premium has not been claimed as deduction earlier. Amount shall be taxable only on the policies issued on or after 1st April, 2023. All policies issued before 01.04.2023 will not be affected and it will continue to remain exempt from tax.  CBDT in its guidelines dated 16.08.2023 has provided with examples the mode of computing tax free amount if more than one policy is taken by the taxpayers. Let us take the Case of Mr. Smart who has taken 5 non-ULIP policies between 2023 to 2024 as under:

In the case of Mr. Smart, the taxability as per Section 10 (10D) read with above referred CBDT guidelines shall be as under:

a) The surrender value of life insurance policy “X” and consideration received under life insurance policy “Y” on maturity will be exempt U/s 10(10D) as the annual premium does not exceed Rs 5,00,000 during the term of these policies.

b) The consideration received under life insurance policies “A”, “B ” and “C” will be taxable since the aggregate of the annual premium payable for the life insurance policies “X” and “Y” for the previous year 2023-24 to 2033-34 was Rs 4 Lakh. If the annual premium of life insurance policies “A” or “B” or “C” is added then the aggregate of the premium will exceed Rs. 5 Lakh during the financial year 2024-25 to 2033-34.

c) To claim an exemption in respect of multiple life insurance policies, the aggregate of the premium payable for all the policies which are claimed to be exempt should not exceed Rs 5 Lakh for any financial year during the term of any of those policies.

TDS on policies which are not tax free:
To keep a track of all life insurance policies which are not exempt from tax, section 194DA provides for deduction of tax @ 1% (20% if no PAN)  if aggregate sum paid in a financial year is Rs. 1 Lakh or more.

Tax Planning & Caution:

a)Taxpayers planning to purchase non-ULIP policies may plan the investment in such a way that the taxpayer utilizes the optimum benefit of exemption on policies up to investment of Rs. 5 Lakh. In above example, Mr. Smart may have taken the one policy of Rs. 1 Lakh as on 01.04.2024 and may have taken the another policy of Rs. 4 Lakh or Rs. 7 Lakh so that the policy of Rs. 1 Lakh would have remained exempt from tax.

b)Taxpayers may note that the taxpayers making investment of more than Rs. 5 Lakh in aggregate in different life insurance companies must keep a track of taxable as well as tax free life insurance policies.  Taxpayers themselves will be required to keep the track of taxable and tax exempt policies as TDS might not be there if policies are taken from different insurance companies and the individual premium is less than Rs. 5 Lakh.

c)Taxpayers may note that the entire amount received on maturity will not be taxable and only the profit element will be taxable (i.e., the maturity amount received less premium paid). If different policies are there, Taxpayers may choose the policies against which exemption may be claimed and the policies which should be offered for taxation.

d)Amount received on the death of the policyholders will be tax free In the hands of the Nominee/Legal heir (whether it’s a ULIP policy or a non-ULIP Policy).

Chart