A term insurance policy is one of the most popular types of life insurance policies. Many people prefer buying term plans over other traditional policies mainly because of their simplicity. When you buy a term plan, you get coverage for a specific period. In the event of your unfortunate demise during the policy period, the insurer will pay the policy benefits, i.e., the death benefit, to your family member.
A critical aspect of buying a term plan is that you must compulsorily appoint a nominee or a beneficiary and mention their details in the application form. It is an integral part of the insurance buying process. You can choose any family member as the beneficiary. It can be a spouse, children, parents or sibling. If you choose a minor as the beneficiary, you must also provide details of their guardian.
You can also choose more than one beneficiary. In such a case, you must also clearly mention the percentage of the payout each member will receive during claim settlement. For example, suppose you appoint both the parents as the beneficiary. In that case, you must clearly mention in the policy application, 60% of the payout to be given to the mother and the rest to the father or vice-versa. In the event of your untimely demise, the proceeds received from the insurance will help them take care of their future expenses and pay off the liabilities (if any) that you may leave behind.
Now that you know about the importance of appointing a nominee, you may ask, are the nominee(s) eligible for paying taxes?
Tax Implication on Term Insurance
One of the significant benefits of buying term insurance is that it allows you to enjoy various tax benefits. The premium you pay for the policy is eligible for deduction under Section 80C of the Indian Income Tax Act. The maximum deduction you can get in a financial year is Rs. 1.5 lakhs.
Apart from the tax benefit available on premium payment, the death benefit received by the beneficiary is completely tax-free under Section 10(10D). When the insurance company pays the death benefit, under the Indian tax laws, the amount is not treated as an income, and therefore is not taxed. Also, there is no limitation on the maximum amount for tax exemption.
Exceptions on Tax Exemption Rule
There are two scenarios when the beneficiary may have to pay taxes on the term insurance payout.
One situation is where the policyholder mentions in their application form that the death benefit must not be immediately after the demise. In such cases, the insurance company holds the amount and pays the amount after the interest accumulation period is over.
The interest amount that the beneficiary receives is treated as a taxable income, and it is taxed accordingly. The beneficiary must pay tax on the interest earned since the policyholder’s demise and not on the actual sum assured.
In another case, the beneficiary must pay tax on term insurance when the proceeds from the policy are in the form of inheritance. Sometimes, when the policyholder does not mention the nominee details, the policy benefits go towards the deceased’s estate.
Although such cases are rare, in this condition, the insurance benefits become part of the deceased’s estate, and the amount is subject to inheritance tax. This does not usually happen as the insurance companies mandate the policy buyers to mention details of the primary beneficiary and contingent beneficiary. If the primary beneficiary passes away before the policyholder, the contingent beneficiary is eligible to receive the payout.
