How life insurance can be an effective tax planning tool

It is commonly believed that the start of the financial year is the correct time to start tax planning. However, it is the March quarter when most salaried individuals undertake the process. An activity that requires great thought is unfortunately carried out in a hurried manner. Most people invest in tax-saving products without evaluating their features and understanding their benefits. When comparing different instruments, it is always advisable to choose an option that offers the mutual benefits of wealth protection, flexibility, value appreciation, and tax savings.

One of the many tax-saving instruments that people come across is life insurance. Although the main objective of a life insurance policy is to provide financial protection for an individual in the face of uncertainties, it also acts as a rewarding tax shelter. Some of the preferred life insurance products include term plans, money back and whole life policies and ULIPs (unit linked insurance plans). Term plans give you pure protection whereas others are a mix of insurance and investment. However, for availing tax benefit all these are treated equally by the income tax department. Hence, all types of life insurance plans qualify for tax benefits on entry and redemption.

Let's understand tax benefits offered by life insurance products:

• One can avail a tax benefit by way of deduction towards premium paid on life insurance policies up to Rs 150,000 under Section 80C of the Income Tax Act, 1961. This also includes premium paid by the person for life insurance for his/her spouse or child.
   
• Under Section 80CCC, if one has taken any pension/annuity plan, he/she is allowed a deduction up to Rs 1 lakh. On maturity of the accumulated amount, 2/3rd of the income gets taxable, while the remaining 1/3rd is tax-free.
   
• If the nominee claims the insurance money in case of the life insured's unfortunate demise, the claim amount is also tax-deductible under Sec 10D. The same benefit is extended to ULIPs and retirement plans under Section 80CCC.
   
• Therefore under Section 80CCE, the overall limit for deduction u/s 80C, u/s 80CCC and u/s 80CCD(1) is Rs 1,50,000/-.
   
• Unlike other savings instrument, life insurance has an additional EEE (Exempt Exempt Exempt) benefit – the amount one invests, the amount that one's investment earns and the amount that one finally receives is all exempted from income tax.

However, before choosing life insurance as a tax-saving instrument one must keep in mind the following points:

• A life insurance policy qualifies for a tax deduction (in case policy is issued after April 1, 2012) only if the premium does not exceed 10% of sum assured. For policies issued before this date, premium should not have exceeded 20% of the sum assured.
   
• If the policy holder surrenders the insurance policy before 2 years and 5 years (for traditional and ULIP policies respectively), the tax deduction will also get reversed.

How to select the right life insurance cover?

Before opting for a life insurance policy, it is prudent to bear in mind that life insurance is uniquely different from all other financial products because it has the protection of your financial interests as its core proposition and thus should be the foundation of your financial plan. You should ideally assess your annual income, liabilities, exiting insurance cover, your current age and financial dependency of the family before opting for the suitable cover and adequate sum assured.

Insurance is a great means to save tax. However, while purchasing insurance one should be mindful of the latest tax changes and rules in order to get the best tax benefits that are available on such products.

TWIN BENEFITS

• Term plans give pure protection while others are a mix of insurance and investment
   
• Life insurance has an additional EEE (exempt exempt exempt) benefit

The writer is chief actuarial officer, Aditya Birla Sun Life Insurance Company Ltd.