Life insurance is one of the essential components of financial planning. It is crucial for all breadwinners because it enables them to ensure their loved ones will be taken care of when they pass away. However, when choosing the beneficiaries for life insurance, one must consider the tax effects they would have to contend with. In many cases, the life insurance policy may also pay out a maturity benefit to you. The taxation of these payouts is something that you should know about before buying either offline oronline life insurance. But before we talk about tax implications, another question needs to be answered- who can be your beneficiary? Here’s taking a closer look at this aspect below.
Understanding Life Insurance Beneficiaries
Not everyone can be your beneficiary in the case of a life insurance policy. Your beneficiary should be someone who can legally claim the sum assured paid out by the insurer in case of your demise within the policy period. This lump sum amount cannot be paid out to just about anyone. Hence, while providing the name of your nominee to the insurer, you should be extra careful. Your loved ones may be chosen as your beneficiaries, while courts can assign beneficiaries for the same purpose in extreme situations.
Two kinds of beneficiaries may be added to the policy:
Primary Beneficiary: This is the nominee named in the life insurance policy document, with the legal claim over the sum assured in case of the policyholder’s demise. However, in case of the unfortunate death of the primary beneficiary before the policyholder, the amount may not be claimed in their name.
Contingent/Secondary Beneficiary: You may add another individual to your policy who is legally entitled to claim the lump sum payout in case of the demise of the primary beneficiary. However, the contingent beneficiary may only get this amount if the primary beneficiary passes away before the policyholder. Post the policyholder’s death, the secondary beneficiary may claim this amount likewise.
Tax Implications Of Life Insurance Payouts
When it comes to life insurance, it’s essential to understand the tax implications for beneficiaries. In India, life insurance policies are generally taxed differently than other financial products, and it’s important to be aware of these rules to ensure that you and your beneficiaries pay the right amount of tax.
- Tax on Death Benefit: The death benefit received by the nominee or beneficiaries is tax-free under Section 10(10D) of the Income Tax Act 1961. This means that the money received by the nominee or beneficiaries as death benefits will not be taxable under any circumstances.
- Tax on Maturity Benefit: Maturity benefits from a life insurance policy are also tax-free under Section 10(10D) of the Income Tax Act, 1961. This means that the money received by the policyholder upon maturity of the policy is not taxable as long as the life insurance premiumpaid for the policy does not exceed 10% of the sum assured.
- Tax on Surrender Value: If a policyholder decides to surrender the policy before maturity, the surrender value received is taxed as per the income tax slab of the policyholder. Under Section 80C of the Income Tax Act, 1961, policyholders can claim a tax deduction of up to INR 1.5 lakh on the premium paid for a life insurance policy. This means the premium paid for a life insurance policy can reduce the policyholder’s taxable income by up to INR 1.5 lakh.
- Tax On Loans Taken Against Policy: If a policyholder takes a loan against the policy, the interest on the loan is taxable as per the income tax slab of the policyholder.
- Tax On Bonus: Bonuses declared by the insurance company are not taxable in the hands of the policyholder.
It’s important to note that tax laws are subject to change, and it’s a good idea to take help from a professional or advisor to understand how the laws apply to your situation. It’s also important to review your policy documents and consult with your insurance company to understand the specifics of your policy and any tax implications that may apply. Thus, understanding the tax implications of life insurance for beneficiaries is an important aspect of financial planning. By being aware of the rules and taking expert guidance when necessary, you can ensure that your beneficiaries have a secure financial future.