Several people buy insurance policies for saving tax as the premium amount is qualified for tax deduction under Section 80C. In this way, they collect insurance products like Ulips and endowment plans with high annual premium with low insurance cover. However, you must know that you are eligible to claim deduction for the whole premium when some conditions are complied with. There is the chance that even with high premiums; you are not eligible to receive deduction on the whole amount of premium. There is some tax rules connected with insurance that you must understand before you buy a life insurance product.
1) There is a common opinion that all life insurance premiums are tax deductible under Section 80C, which is not correct always. If the insurance policy originated before or on April 2012, the deduction is limited to only 20% of the sum assured and for policies generated after April 2012, the deduction is restricted to only 10% of the sum assured. Presume, an individual purchased an insurance policy with a premium of Rs 8,400 with a sum assured of Rs25, 000 on March 2013. The deduction would have the limit of Rs.2, 500 only and there would no claim on the remaining amount. Currently, insurance companies tender policies with the premium being less than 10% of the sum assured.
2) If the policy is surrendered before the minimum lock-in period, the tax befits availed for the policy term is reversed. For unit-linked insurance plans, such period is 5 years and for other products it is 2 years. For example, if the Ulip is surrendered before the lock-in period, the income tax benefit claims are reversed. The deduction claimed is added to the income of the individual and taxes are calculated according to requisite slab for the year it was surrendered.
3) An individual is able to claim deduction under Section 80C for the premium paid for self, spouse and kids and no deduction would be permissible for insurance premiums paid by parents, in-laws and siblings.
4) Most individuals are unaware that insurance proceeds are totally taxable when the insurance premium exceeds 10% of the sum assured (excluding when it is received after the demise of the insured). The government has made it compulsory for insurance companies to deduct a TDS (tax deductible at source) @ 2% from the insurance proceeds when the policy fails to meet the criteria. Nevertheless, there would be no TDS deduction when the maturity proceeds are below Rs1 lakh.