In today’s uncertain times, it has become more important than ever to create security for yourself and your loved ones. Savings and investments are the steps you take to secure your future. However, what about your family when you suddenly lose your life? This situation is where life insurance is needed. Life insurance is a must-have financial instrument that takes care of the financial needs of your loved ones in your absence. It ensures that your family does not face any financial turmoil in your absence.
By definition, life insurance is a contract between the policyholder and the insurance provider. According to the contract, in case of the demise of the policyholder, the life insurance company is accountable for paying a sum assured to the beneficiary of the policy. In exchange for this protection that is offered by the insurance company, the policyholder has to pay regular premiums as per the contract.
Several people purchase life cover to avail tax benefits of life insurance. However, the true purpose and the right reason to buy it is to protect your family in your absence. With uncertainties in life, it is important to have an income replacement if the policyholder loses their life.
Who is a beneficiary?
When you buy life insurance, fill out several details, during which you will come across the term of a beneficiary. A beneficiary, also known as a nominee, is the person who will receive the proceeds of your policy if you lose your life during the policy duration. It can be a member of your family, be it your partner, your parent, or your sibling, whom you hold accountable to take care of the finances if anything was to happen to you. It is important to choose a beneficiary whom you can trust. Irrespective of the life insurance plans you choose, ensure that you choose sufficient sum coverage for your beneficiary. The key rule here is that the amount should be enough to take care of your loved ones over the years along with repaying your debt if any.
Are beneficiaries liable to pay taxes on life insurance?
Tax benefits of life insurance are one of its most defining and popular features. The premiums that you pay for your policy are exempt from taxes under Section 80C of the Income Tax Act. Also, the death benefits that the beneficiary receives are also exempt from tax. According to Section 10 (10D) of the Income Tax Act, the amount received by the beneficiary as a death benefit is deemed completely tax-free.
Are there any exceptions to this?
There is a situation where the tax implication towards the beneficiary comes into the picture. This is when the policyholder, during the purchase of the policy had specified that the death benefit should not be immediately given to the beneficiary. In such a scenario, the insurance company holds the amount for the period between the policyholder’s demise to when the beneficiary receives the death benefit. The beneficiary earns interest from the death benefit that the insurance company is holding. Later, the beneficiary gets the death benefit along with interest earned on it. The portion of the death benefit received that amounts to interest is subjected to taxation. The beneficiary is not required to pay tax on the death benefit but on the interest earned on it.
Taxation to beneficiaries also is a case when estate and inheritance come into the picture. For some life insurance plans, the proceeds received from the demise of the policyholder are directly transferred to the estate of the deceased. This is the case if the beneficiary loses their life before the policyholder or there was no beneficiary mentioned in the policy. This rarely happens, but if it does, the sum assured becomes part of the legacy of the policyholder. Once the sum assured is a part of the estate or legacy, there are tax implications. This is because the sum assured will be subjected to an estate or inheritance tax.
Usually, the beneficiaries do not pay any taxes on the death benefit they receive from the insurance companies. However, the above two cases are rare exceptions when it might happen.