How to Optimise Tax on Life Insurance Policies having Annual Premium exceeding Rs 5 Lacs?

The Finance Act 2023 has ended the 'tax-holiday' glory of the maturity proceeds of high-ended life insurance policies/endowment plans, requiring payment of annual premium in excess of Rs 5 lacs. The section 10(10D) of the Income Tax Act has been amended to provide that the maturity proceeds received under a life insurance policy, (other than ULIPs), issued on or after 1.4.2023, shall not be exempt, if the premium payable in any year, during the term of such policy, exceeds Rs 5 lakhs.

The amended section also stipulates that if the policy holder holds and pays premium in respect of multiple life insurance policies, issued on or after 1.4.2023, the exemption from income tax in respect of the maturity proceeds shall be available only in respect of such policies where the aggregate annual premium does not exceed Rs 5 lakh, during the term of any of such policies. It is pertinent to mention here that the clubbing or aggregating of annual premium for the purpose of determining the threshold annual premium limit of Rs 5 lakhs in respect of multiple life insurance policies, is to be done only for those life insurance policies which have been issued on or after 1.4.2023. Further the maturity proceeds of such life insurance policies, have been made taxable under the head income from other sources under a new section 56(2)(xiii).

Amidst such taxing times for the high-ended life insurance policies, the CBDT has brought in some respite by way of its Circular No. 15 of 2023 dated 16.8.2023. This Circular contains guidelines to remove difficulty in practical implementation of the amended provisions of section 10(10D), concerning the taxability of maturity proceeds of life insurance policies, issued on or after 1.4.2023. The Circular also contains practical examples for better understanding and clarity of the stakeholders, in this respect.

Among other things, the key take-away and main highlight of this Circular is the clarification in respect of the taxability of the maturity proceeds of life insurance policies, in cases where the policy holder holds multiple life insurance policies issued on or after 1.4.2023, and the policy tenure or part of the tenure of such policies coincides with each other. The Circular clarifies that in such cases, the policy holder shall have the option to choose the policies which can be claimed as exempt and which can be offered for taxation.

The Circular clarifies that in order to optimise the utilisation of the aggregate exemption threshold limit of premium of Rs 5 lakhs, in respect of multiple LIC policies, issued on or after 1.4.2023, the policy holder should first exhaust this threshold annual premium limit of Rs 5 lakhs, in respect of those policies which are having the higher maturity proceeds in value, so that the LIC policies having comparatively lower value of maturity proceeds are subject to income tax.

It is pertinent to mention here that in majority of the cases, the absolute value of the maturity proceeds will be the deciding factor in making the choice of the insurance policies for claiming exemption u/s 10(10D), as compared to the net yield basis. The Net Yield of the life insurance policy is equivalent to Maturity Proceeds of the policy – (Annual Premium * Policy Tenure).

The Net Yield basis may not be practical as the premium paid in respect of the policy is allowed as deduction from the taxable amount of maturity proceeds only if the policyholder has not claimed deduction in respect of such premium in any earlier years under any other sections like section 80C. In all likely-hood, the policyholder would have already claimed deduction in respect of the premium paid on life insurance policy u/s 80C of the Act, and as such it will be the gross maturity proceeds amount, which will be taxable and not the net yield amount after claiming deduction of premium paid. However, if the policyholder is opting for the new personal tax regime, then the net yield basis may be considered for making this choice.

Consider this example: Mr. X, is holding the undermentioned life insurance policies.

Life Insurance Policy	A	B	C	D
Date of Issue	1.4.2023	1.4.2024	1.4.2024	1.4.2024
Annual Premium (Rs.)	1,00,000	1,00,000	1,50,000	3,00,000
Sum Assured (Rs.)	10,00,000	10,00,000	15,00,000	30,00,000
Consideration received on maturity on 1.5.2033	12,00,000
Consideration received on maturity on 1.5.2034		12,00,000	18,00,000	34,00,000

The aggregate annual premium of the above four life insurance policies A, B, C and D is Rs 6,50,000/-, which is in excess of the threshold annual premium limit of Rs. 5,00,000/-, and so Mr. X is required to make an intelligent decision in order to optimise his tax outflow. This can be done if Mr. X offers the maturity proceeds of Rs. 12,00,000 in respect of Policy A to tax and not claim exemption u/s 10(10D). This will enable him to make use of his threshold annual premium limit of Rs 5 lakhs for claiming exemption in respect of the higher value maturity proceeds of Rs. 18,00,000/- of Policy C, with annual premium of Rs. 1,50,000/- and the maturity proceeds of Rs. 34,00,000/- of Policy D, with annual premium of Rs. 3,00,000/-. He will have to offer the maturity proceeds of Rs. 12,00,000/- in respect of Policy B to income-tax u/s 56(2)(xiii) of the Income Tax Act.

Thus, by offering the comparatively lower value maturity proceeds of Rs. 24 lacs in respect of Policy A and B, to tax and choosing the higher value maturity proceeds of Rs. 52 lacs in respect of Policy C and D, for claiming exemption u/s 10(10D), Mr. X can optimise his tax outflow.

The Circular also clarifies that the GST component is to be excluded in calculating the threshold limit of Rs 5 lakhs of annual premium. The term life insurance policies, wherein the maturity proceeds are given only in the event of the death of the policy holder to the nominee, are also excluded from taxability, and also the premium paid in respect of such term life insurance policies is not be considered for the purpose of aggregating annual premium of Rs 5 lakhs.