Life Insurance & Disability Insurance Proceeds

Life insurance policies are designed to meet the financial requirements of the insured’s family after his death and in case the insured outlives the policy tenure, it gives a maturity benefit also. While disability insurance acts as an income replacement if the insured meets a fatal accident and becomes disabled, due to which he is no longer able to work.

Both are essential ways to protect your income in case of an unforeseen event. In both cases, when a claim is filed, the insurer verifies it to determine the proceed amount, and payment option. Generally, these proceeds are tax-free but with certain exceptions. Let us understand how life insurance and disability insurance proceeds work.

Life Insurance Proceeds

Life insurance proceeds are available in a wide range for the insured or the beneficiary. These proceeds are paid as,

Death benefit paid to the beneficiary in the event of the demise of the insured, or
Maturity benefit paid to the insured on completion of the policy tenure.

There are two options in which the beneficiary can get life insurance proceeds. It can be paid out in lumpsum, including bonuses and loyalty incentives, or there is an option of periodic payments as well. In periodic payments, a part of the benefit is paid in a lump sum, and the remaining is converted into instalments paid over a predecided term. This way beneficiary has a steady flow of income to meet regular expenses.

In addition to these benefits, there are tax benefits applicable to a life insurance policy. However, these proceeds are taxable in certain cases.

How are Life Insurance Proceeds Taxed?

According to Section 10(10D) of the Income Tax Act, life insurance proceeds including any bonus that is paid as a death benefit or maturity benefit or on surrender of the policy, are completely tax-free subject to certain conditions. Following are the conditions in which the policy proceeds become taxable:

If any policy is issued after 1-4-2003 and before 31-3-2012, and the premium payable in a year is more than 20% of the sum assured, the proceeds are taxable in the hands of the insured.
For the policies issued after 1.4.2012, if the premium is more than 10% of the sum assured, the proceeds become taxable.
For policies issued after 1.4.2013, the 10% limit is changed to 15% as per Income Tax Act and rules if the insured has a disease or disability. The disability in such cases has to be the one listed in section 80U, and the disease has to be the one listed in section 80DDB.
If the premium paid in a year is more than the prescribed limit of 10%, 15% or 20%, the full proceeds amount is taxable. In case the insured dies, the policy proceeds are tax-free in the hand of the nominee.
If the proceeds are taxable as per section 10(10D) and exceed Rs. 1,00,000, a TDS of 2% applies to the sum received by an insured according to section 194DA of the Income Tax Act. Note that an insured should submit his PAN to the insurer; otherwise a TDS is applied at a 20% rate instead of a 2% rate.

For ULIPS, if the annual premium is more than Rs. 2.5 lakhs, a capital gain tax is applicable on the maturity proceeds.

Disability Insurance Proceeds

Disability insurance covers the loss of income due to temporary or permanent disability caused by an accident or an illness resulting in an inability to work. Some factors that affect the cost and proceeds of disability insurance are the nature of the income, the period for which the benefits are paid, the medical history of the insured and the waiting period. The disability insurance proceeds are generally 60 to 80% of the pre-disability income and are paid till a specified period.

Let us understand how disability insurance proceeds are paid to the beneficiary.

In case the insured is fully and permanently disabled, he receives 100% of the sum insured as the policy proceeds. Long-term disability also covers illnesses like heart disease, mental illness, cancer etc.
For partial disability, a percentage of the sum insured is paid out according to the extent of disability.
For short-term disability, proceeds are paid as weekly benefits to replace the loss of income up to the specified period. The insured continues to receive the benefits till he is recovered or till the coverage amount lasts.

Disability insurance proceeds are also eligible for tax benefits as per section 80U of the Income Tax Act of India. To register a claim, the insured needs to provide a medical certificate which certifies the disability and a return of income certificate.

Tax Deductions Available for Disability Insurance Proceeds

The deductions that can be availed by a disabled individual are fixed and do not depend on the actual expenses incurred. For eg. If you spent 20,000 on the treatment of a disabled individual, you can still get a fixed deduction of Rs. 1.25 lakhs if the disability is more than 80%. These deductions are as follows:

Under Section 80U -

Under this section, an insured can claim deductions for his medical treatment. The deductions are,
1. A fixed amount of Rs. 75,000 is deductible if the insured’s disability is between 40 to 80% (Person with Disability)
2. For disability more than 80% (Person with Severe Disability), a fixed deduction of Rs. 1,25,000 is available.
3. No tax benefits are available for disability below 40%.
Under Section 80DD -

Under this section, the insured can claim deductions for the treatment of a dependent family member. The deductions available are the same as mentioned under section 80U. Note that no deductions are available if deductions have already been claimed under section 80U.

Conclusion

Most people invest in an insurance policy without understanding the tax implications on the insurance proceeds. They are under the impression that the proceeds are tax-exempt, but it is not the case. Understanding taxation makes a big difference in making the right choice.

Frequently Asked Questions

Q. What are the proceeds from life insurance?
- Proceeds from life insurance are benefits paid by the insurance company as a result of a claim request. When a claim request is approved, the proceeds are either paid as a death benefit or as a maturity benefit.
Q. Are disability insurance payments taxable?
- Yes, disability insurance payments are taxable if the disability is below 40%. In case of disability, more than 40%, there are tax benefits available according to the degree of disability.
Q. How are life insurance beneficiaries paid out?
- Life insurance beneficiaries are paid out in two ways: either in a lump sum or in periodic payments.
Q. Does disability insurance count as income?
- Disability insurance act as a replacement for the loss of income and pays a certain percentage of income.
Q. How do I know if my disability income is taxable?
- Disability income is taxable for individuals with less than 40% disability. There are tax benefits available for individuals with 40 to 80 % disability.