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What are the tax deductions available under insurance?

    IndianMoney.com Research Team | Friday, August 20,2010, 06:47 PM
 

Imagine a situation where an individual works with full sincerity to earn an income to lead a comfortable life, but due to lack of tax planning he ends up losing a major chunk of his earnings by paying tax. Have you ever faced this jeopardy?

Taxes are essentially one of the major sources of income to the government. Government levies taxes in order to fund various projects and foster economic development of the country.

Tax planning should form a part of financial planning activity. Efficient tax planning can minimise the tax liability of an individual. One should understand clearly that tax planning is not tax evasion. Earlier on the Tax laws were stringent and the provisions were not lucrative enough to drive people to invest keeping tax planning in mind.

With the amendment of Income Tax Act and the passage of time, there seems to be a dramatic improvement in the investment options available to save tax. Insurance has always been viewed as an investment and a tax saving tool. One major mistake we all do is to plan for tax saving only towards the last quarter of the financial year, and thus, we end up taking many investment decisions in haste.

Therefore assessing each option carefully and then choosing the right investment plan has become pivotal in making tax saving a profitable exercise. Insurance is one such tool. If any person knows the benefits under the Income Tax Act, Tax Planning will be much simpler activity.

What You should know about Insurance?

Insurance can be defined as a contract between two parties wherein one party (insurer/insurance Company) agrees to compensate for occurrence of loss of property/risk to life of the other party (insured) on payment of certain sum of money(premium) to the insurer.

ULIPs :

ULIPs stand for Unit linked Insurance Plans. These are a type of investments which have the characteristics of both insurance and mutual fund. A part of the invested amount goes into insurance cover and remaining into an asset class. ULIPs usually have higher entry costs, brokerage and commission. The price of insurance cover is higher in a ULIP plan compared to a plain insurance policy.

These can be a tax saving investment because; the premium paid towards the ULIPs is exempt under Section 80C of Income Tax Act. Provision of Section 80 C states, any tax payer can invest upto Rs. 100000/- in EPF, PPF, life insurance premium, NSC, infrastructure bonds, pension plan premium, tax saving mutual funds, home loan repayment without any sub limits. Also any profit or the final sum assured is exempt from tax. [Section10 (10D)]

Child Plan :

These are the plans that provide cover to the life of the child’s parents/guardian/grandparents. These are term plans. These plans basically ensure that the child’s future is not put in jeopardy in case of death of the parent/guardian/grandparents of the child. Usually child plans are calculated to mature at important events in child’s life, like pursuing higher education or marriage. The sum is receivable irrespective of the survival/death of the insured.

These plans also provide an exempt on tax on the premiums paid as per section 80C and the sum assured received is also exempt from tax. [Section10 (10D)]

Pension Plans :

It is a plan that assures, one will continue to earn income and enjoy a comfortable life even after retirement. It has gained importance off late because of job insecurity, mid-career shifts. Mostly insurers provide two types of pension plans, endowment and unit-linked plans.

Premium paid towards these plans are exempt upto a maximum limit of Rs.100000/-. [Section80C]. Also the sum assured is exempted.

Term-Life policies :

These are the kind of insurance contracts which cover the life of an individual over a period of time. The benefits will be paid if and only if the risk happens during the term of the policy.

Pure Endowment Plans :

These are similar to term life plans. The basic difference is that the benefit will be paid if and only if the insured survives the term.

Endowment Assurance Plans :

The best form of explaining this kind of a policy is that it is a combination of term life policy and pure endowment plan. This is a form of life insurance that assures one about the payment of a specified amount on a specific date or to the beneficiary upon the death of the insured before that date.

Money-Back Plans :

These are ideal investment options for those who look for both insurance and savings. In these kinds of policies a certain percentage of the sum assured is remitted to the insured throughout the term of the policy. These remittances are tax-free. In case the insured survives the term, he receives the corpus with accrued options like bonus. In case of death of the insured before the expiry of the term, the nominee or legal heirs get the sum assured irrespective of the instalments received, with accrued benefits.

Tax Benefits :

Premiums paid towards all the above mentioned insurance plans are exempt upto a maximum limit of Rs.100000/- according to the provision of Section80C. Also the Provision of Section10 (10D) provides for a complete exemption on receipt of sum assured.

Health (Med-Claim) Plans :

This plan falls into the general insurance category. This basically covers medical expenses one may incur on account of illness and subsequent hospitalisation. However, life insurance companies have started coming up with health plans.

According to the provisions of Section 80D, Amount paid towards the premium of med claim insurance policy by an assessee can be claimed for deductions The deductions available under this section are :

  • Rs.15000 or premium paid whichever is less in case of medi-claim premium paid for self and non senior citizen dependants and an additional deduction of Rs.20000 or premium paid whichever less in case of medi-claim premium is paid for dependant senior citizens.
  • In case a senior citizen pays premium for himself towards his medi-claim policy then exemption available is upto Rs.20000/- or premium amount paid whichever is less.

This can be explained with the help of the following example

Mr. Swaminathan pays premium on Mediclaim policy for self – Rs. 8000/-, for spouse – Rs.10000/-, for father (aged 70 years) = 6000/- and for father in law (aged 72 years) - Rs. 5000/-.

Mr. Swaminathan pays a total of Rs.18000/- for him and his wife. Deduction available is Rs. 15000/premium paid whichever is less.

He has also paid Rs.6000/- towards the premium of his father and thus he is eligible for an additional deduction of Rs.20000/-or premium paid whichever is less.

Thus total deduction available to Mr. Swaminathan in this case is Rs.24000/-.

He is not eligible for any deduction for Mediclaim premium paid for his father in law, because he is not a direct dependant.

Section 80DD provides for an exemption of premium paid for medical treatment of disabled dependent, of Rs.50000/- and an exemption of Rs. 75000/- in case of severe disability.

We often buy insurance policies without analysing the benefits. For instance insurance policies like endowment, money back don’t make good investment options because of

  • Longer lock-in periods
  • Larger initial outlay
  • Lesser relative returns
  • Poor surrender value

Some tax planning tips to sum up the article would be :

  • Utilize the Provision of Section 80 C
  • Learn to think beyond Section 80 C, Avail benefits under sections 80D and 80DD
  • Restructure your Salary

Many investors feel tax planning is little more than a compulsory business activity to save tax. Tax planning is a lot more than blindly applying to insurance policies. Tax planning has to be an activity that contributes to personal financial goals as well as reducing the tax liability. Tax planning has to be taken up as a continuous activity rather than a onetime affair.

IndianMoney.com Research Team

The research team at IndianMoney.com comprises of certified and experienced professionals who share the company's vision to make every Indian financially literate by equipping every Indian with right and unbiased advice. IndianMoney.com research team provides newsletters, articles, videos and FAQs on various financial products and concepts only to help you make wise financial decisions.

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