Is life insurance taxable? – Forbes Advisor INDIA

The primary purpose of life insurance is to provide a death benefit that will help you provide for your loved ones financially. A bonus is that life insurance death benefits are generally not taxed. Since the coverage amounts can be very high – up to lakhs – it is a significant advantage that the life insurance payout is tax-free.

But some aspects of life insurance don’t get past the tax authorities.

Is a life insurance payout taxable?

Death payouts from life insurance policies are generally not taxable to the beneficiaries. This means that the beneficiaries will receive the money without a tax burden hanging over their heads.

However, there are certain situations in which a death benefit from a life insurance policy may be taxable. Here you can read when you should prepare for a tax assessment.

You are a beneficiary of a life insurance policy and receive interest on a death benefit

Most life insurance payouts are paid out in a lump sum immediately after the death of the insured person. But if a beneficiary chooses to delay the payout or make the payout in installments, interest may accrue. In that case, the interest paid to the beneficiary may be taxed.

The life insurance payout goes to a taxable estate

Most life insurance payouts are made tax-free directly to the life insurance beneficiaries. But if a beneficiary is not named, or has already died, where does the life insurance death benefit go? It ends up in the insured’s estate and may be taxable along with the rest of the estate.

The payout from the life insurance policy itself is usually tax-free; Complications arise if the person has no beneficiary or if the beneficiary is deceased. The payout goes to the insured’s estate and any income from this amount may be taxable. For specific advice, we recommend that you consult a legal advisor or tax advisor.

The life insurance policy involves three different people

Death benefits from a life insurance policy can become a taxable gift in a situation where three people perform three different roles in connection with the life insurance policy. The positions include:

• The policy owner. This is the person who purchased the policy and is ultimately responsible for paying the premiums.
• The insured. This person’s life is covered by the life insurance policy.
• The beneficiary. This person receives the death benefit when the insured person dies.

In India, death benefits are generally tax-free under Section 10(10D) of the Income Tax Act. There is no annual or lifetime exclusion limit for gifts for tax purposes, but gifts from non-family members exceeding INR 50,000 may be taxable under certain circumstances.

Is the cash value of a life insurance policy taxable?

If you have a cash value life insurance policy, such as whole life insurance, you can usually access the money through a withdrawal, a loan, or by surrendering and terminating the policy.

One of the reasons to buy a cash value life insurance policy is to have access to the money that builds up within the policy. When you pay premiums, payments generally go to three places: cash value, the cost of insuring you, and policy fees and charges. Money in the cash value account grows tax-free, based on the interest or investment gains it earns (depending on the policy). But once you withdraw the money, you could face a tax bill.

Money extracted from cash value generally consists of two parts:

If your life insurance policy is a “modified endowment contract,” or MEC, different tax rules apply and you may want to consult a financial professional to understand the tax implications.

Here are situations where the cash value may be taxable.

You give up the life insurance policy

There may be times when a policyholder no longer wants or needs the life insurance policy. You can take the surrender value of the life insurance policy with you and the insurer will terminate the coverage. The amount you receive is your cash value minus any surrender charges. You can generally expect to receive a surrender charge within the first 10 or 20 years of owning the policy, and over time the surrender charges are phased out.

However, you will not be taxed on the entire surrender value. You will be taxed on the amount you received minus the policy basis, or on the total premium you paid for the policy. This taxable amount reflects the investment profit you have taken.

Suppose the premiums you have paid over many years add up to INR 38,000 and your total cash value is INR 45,000. The portion of the payout that would be taxed is INR 7,000, which represents the investment gain.

You have taken out a policy loan and the life insurance policy is ending

If you have a cash value policy and take out a life insurance loan against it, the loan is not taxable as long as the policy is in force. But if the policy ends before you repay the loan, you could be hit with a tax bill. For example, the coverage ends if you surrender the policy or if it expires.

The taxable amount is based on the amount of the loan that exceeds your policy basis. The policy basis is the part that you have paid in premium. Amounts “above basis” are based on interest or investment gains on cash value.

One way to access all your cash value and avoid taxes is to withdraw the amount that makes up your policy basis; this is not taxable. Then access the rest of the cash value with a loan, also not taxable.

If you die with a loan that violates the policy, the death benefit will be reduced by the outstanding loan amount.

You sell the life insurance policy

You surrender your life insurance policy to receive its cash value, which may be subject to taxes on any gains. Selling life insurance to another party is not common and should be better arranged. The tax consequences of surrendering or selling a policy depend on the value received and whether it exceeds the policy basis.

Summary: When is life insurance taxable?