Term Insurance

Is Term Insurance Tax-Free?

by SMCIB on Wednesday, 26 April 2023

Is Term Insurance Tax-Free?

Term insurance is an easy and straightforward way to provide financial security to your loved ones in the event of your untimely demise. It is similar to planting a tree. You may not be alive to see the full benefits, but your family will be able to enjoy the fruits of your labour long after you're gone.

Did you know a term insurance policy not only secures your family's future but also offers you tax benefits?

Yes, by purchasing a term insurance policy now, you can ensure that your loved ones will have the security and protection they need even after you are gone while enjoying the added bonus of tax savings.

So, term insurance offers tax benefits. But is it tax-free?  Let’s discuss.

Before we begin, let's understand what term insurance is -
 

Term Insurance

Term insurance is the simplest form of life insurance. If you pass away while the policy is active, the insurance company will pay your family a sum of money - providing them with a lasting sense of security and peace of mind. They will receive the cover amount under your term insurance policy, depending on the claim payout option chosen by you during policy purchase. It can be paid as a lump sum, monthly instalments for a specific time span, or a combination of both.

Term insurance is a pure risk insurance cover. So, you won't receive any benefits if you survive the policy period.
 

Benefits Of Term Insurance

Here are some reasons why term insurance is a wise choice -
 

1️⃣ Secure your Family Financially

If you have term insurance, you will be able to ensure that your family is financially protected should the worst happen to you during the term of the policy. So, you can be assured that your family is provided for even in the toughest of times.

The claim amount can help them meet long-term goals such as repaying outstanding loans, funding children's education, etc. On the other hand, it can act as an income replacement to keep up with their short-term goals such as covering utility bills, EMIs, rent, etc.

For example, Mahesh, 30, lives with his wife and his 5-year-old son - who are both dependent on him. He wants to secure their future so he buys a term insurance with a sum assured of 1 Crore for a policy duration of 30 years. In case Mahesh passes away during the policy period, his wife will receive a death benefit of Rs 1 Crore. She can use the money to take care of her son’s education and her household needs. However, if Mahesh survives the policy period, he won’t receive anything.
 

2️⃣ Global death coverage

Term insurance also offers global coverage in the event of death. It covers every type of death, except suicide in the first year of buying the plan. In this case, the paid premiums are returned to the nominee instead of the cover amount.
 

3️⃣ Simple and straightforward

Term life insurance is the simplest type of life insurance. As mentioned earlier, your family will receive a fixed amount of money in case you pass away during the policy period. Your only responsibility is to pay all your premiums on time.
 

4️⃣ Affordable premiums

With term insurance, you get great coverage without breaking the bank. It has very low premiums. For instance, a 1 crore term cover costs only Rs 900 per month. This means that if you pass away while the policy is active, your family will receive Rs 1000 for every rupee you invest. So, term insurance is an ideal choice for anyone who has financial dependents and is looking for a cost-effective insurance option that provides a high level of financial protection.
 

5️⃣ Highly Customisable

Your term insurance policy can be tailored to perfectly fit the needs of you and your family. Here are some commonly available customisation options:

? Premium Payment Frequency
You can choose the payment cycle that works best for you depending on your convenience. You can pay the premiums annually, half-yearly, quarterly, or monthly.

Pro tip: Keep standing instructions for premium payment on your bank account, not on your credit card or debit card. The cards have an expiration date, which may cause problems with your payment. If the payment fails, your policy can lapse.
 

? Premium Payment Model
There is also an option of choosing your premium payment term. This is basically the duration for which you will have to pay the premiums. Based on your financial capacity and life stage, you can select your premium payment term. Whether you wish to pay the premiums in one go, in smaller, more manageable instalments, or throughout the policy tenure - the choice is all yours.

The premiums can be paid in the following ways:

 

 

Regular Pay Option

Limited Pay Option

Single Pay Option

 

How does it work?

You pay the premiums regularly until the end of the policy term.

 

 

You can finish off your premium payment liability in a limited number of years and enjoy coverage till the end of the policy term. Some of the limited pay options available with term insurance include 5-pay, 10-pay, 15-pay, 20-pay etc.

 

 

 

You can pay your entire premium in one shot  during policy purchase and remain covered for the rest of the policy term.

 

In what cases is it a good choice?

  • If you are young and have just started working.
  • You want to split the premium into manageable portions.
  • You envision a regular income throughout the policy term.
  • You want to get done with paying premiums in a faster timespan. 
  • You won’t be working for a long time.
  • You expect an irregular income. For instance, if you are self-employed and are concerned that your future earnings might not be steady, you can choose this option to complete your premium payments faster.

 

If you have a large sum of money that can be invested.

Example

Rajesh, a bank employee, purchases a term insurance policy with a sum assured of Rs 1 crore for a policy duration of 30 years. Since he is a salaried individual, he opts for the regular pay option. So his premium payment duration will be 30 years and will have to pay the premiums over this entire period.

 

Mahesh runs a small business. He purchases a term insurance policy with a sum assured of Rs 70 lakhs for a policy duration of 20 years. He feels that he may experience an unstable flow of income in future, so he opts for the limited pay option. He chooses the 10-pay premium payment term option, so he can complete his premium payment liability within 10 years and still be covered for the rest of the policy period, i.e., for the remaining 10 years.

Madhav got a huge sum of money from his mutual fund investment. He decides to purchase term insurance with a sum assured of Rs 1 Crore and a policy duration of 35 years. Since he wants to pay the entire lump sum in one go, he chooses the single-pay premium payment option. He will need to pay the entire premium at the time of purchase and will remain protected for the entire policy duration of 35 years.

 

 

Increasing Cover Option
Your responsibilities only increase as you age. Your parents may retire, you may get married, you may have children, and so on. The cover amount you feel to be enough today may not be so tomorrow. And so, it is essential to ensure that your cover amount can take care of these evolving needs. Term insurance offers an increasing cover option, wherein your plan's cover amount will increase by a specific percentage until it reaches a predefined limit. You can opt for this option if your financial obligations are likely to increase over time, like your child's higher education or wedding. The option is also useful if you're looking for inflation-proof coverage.

 

? Claim Payout Options
If you are the sole breadwinner of your family, they can face huge financial distress if something happens to you. Having a financial backup can provide your family with a great deal of comfort, giving them a sense of stability during a difficult time. This can be achieved by purchasing term insurance. By ensuring that your family is taken care of financially, you are giving them the resources to move forward and work towards their future.

However, if your nominee isn’t financially well-versed, a sudden and large influx of money might confuse them and lead them to make poor financial decisions. So, term insurance gives you the option to configure how you want your family to receive the claim amount - making it easier for them to manage their finances.

Here are some claim payout options available under the term insurance policy -

 

 

Lump-sum Payout

Monthly Income Payout

Lump-sum With Monthly Income Payout

How does it work?

The entire claim amount is credited as a lump sum to the nominee's bank account.

If you choose the monthly income payout option, the claim amount is paid to your family in fixed monthly instalments for a certain period of time.

 

This is a combination of the other two options. A part of the claim amount is paid to the nominee as a lump sum and the remainder as monthly instalments.

When is it a good choice?

If you have any pending loans or liabilities that need to be paid. This makes the nominee's life easier, as the claim amount is immediately available to use for loan repayment or other financial obligations.

You may benefit from this option if you don't have any loans or liabilities, but wish to cover your family's daily needs such as utility bills, EMIs, etc.

 

It is a suitable option if you want a lump sum to take care of outstanding loans or liabilities as well as monthly instalments to help your nominee with everyday expenses.

Example

Diya purchases a term insurance plan with a sum assured of Rs. 1 Crore. She opts for the lump-sum payout option. If Diya passes away during the policy term, the entire amount will be given to her nominee as a lump sum.

 

Let’s recall Diya’s example. If she opts for the monthly income payout option, the claim amount of Rs 1 crore will be given to her family in instalments on a monthly basis - if she passes away during the policy term.

 

Taking Diya’s case again. If she opts for the lump sum with the monthly income payout option,  then as per her policy’s T&Cs, 50% of the amount will be paid as a lump sum and the remaining 50% will be converted into monthly payouts. In this case, Rs. 50 lakhs will be paid as a single payment and the remaining Rs. 50 lakhs will be split into monthly instalments as per her preference and given to her family - if she passes away during the policy term.

 

 

? Riders
Riders are optional add-ons that can be added to your base term insurance policy at a certain extra cost. They offer an additional payout under specific circumstances. You can opt for them with no additional paperwork or medical tests (beyond the ones you have already gone through for your base term insurance policy). There is a wide range of riders that you can add to your term insurance policy, like a waiver of premium rider, critical illness rider, accidental death benefit rider, etc. For example, if you choose to add a critical illness rider, you will receive an additional lump sum payment if you are diagnosed with a listed critical illness.

 

6️⃣ 3-Year Claim Payout Guarantee

According to Section 45 of the Indian Insurance Act of 1938, a term insurance company cannot investigate or reject an insurance claim based on fraud, misstatement, or suppression of facts if the policy has been in force for three years continuously. As long as you pay your premiums on time, your family will receive the claim amount if the term insurance policy completes three years.
 

Coming To The Crux - Is Term Insurance Tax-Free?

Term insurance payouts are exempt from taxation in India. The proceeds from a  life insurance policy, including term insurance, are exempt from taxation under Section 10(10D) of the Income Tax Act of 1961.  In the event of your untimely demise during the policy term, the death benefit paid to the nominee will not be subject to any income tax.

In addition to this, you can also get deductions of up to Rs 1.5 lakhs on the premiums paid for a term insurance plan under Section 80C of the Income Tax Act of 1961.
 

Wrapping up!

Term insurance plans are affordable and straightforward, making them one of the most popular choices for those looking for financial security for their loved ones. It is an ideal option if you want to safeguard them with a tax-free financial backup.

Insurance Knowledge Videos