For decades, insurance policies in India enjoyed a near-legendary status, safe, tax-friendly, and often recommended more out of habit than financial strategy. But the world has changed. Tax laws have changed. Insurance products have definitely changed. And most importantly, what you need to watch out for has changed.
Let’s demystify one of the most misunderstood areas in personal finance: taxation of insurance policies, new and old. If you thought insurance was a “buy, forget, and get tax exemption later” product, this discussion will make you rethink.
Let’s break it down, clearly, cleanly, and with a pinch of wit.
How We Reached Here: A Quick Walk Through Insurance History
When LIC came into existence in the 1950s, India did not have much appetite for insurance. Joint families were the original “risk cover,” and professions passed naturally through generations. To convince people to buy insurance, the government added sweeteners: money back plans and tax exemptions.
For years, Section 10(10D) made insurance maturity proceeds fully tax-free. A perfect deal, until the fine print started being misused.
As insurance companies brought in more investment-heavy products and low-risk, tax-free returns, policymakers stepped in. Over the last two decades, multiple restrictions were introduced to ensure insurance remained insurance, not a tax-free investment hack.
What Changed First: 20%, Then 10%
Earlier policies received tax exemptions with only one condition:
Your premium should not exceed 20% of the sum assured. This applied to policies issued from 1 April 2003 to 31 March 2012.
From 1 April 2012, this threshold tightened to 10%.
Translation: your sum assured should be at least ten times your annual premium. If not, your maturity becomes taxable.
Simple enough, until ULIPs entered the picture and quietly shook things up.
The ULIP Twist: When Mutual Funds and Insurance Started Competing
ULIPs (Unit Linked Insurance Plans) offered equity-like investment with insurance cover. Mutual funds were taxed. ULIPs were not. You can imagine what happened next.
So, from 1 February 2021, a major rule arrived:
If your ULIP premium for policies issued after this date exceeds Rs 2.5 lakh per year, the maturity is taxable.
And yes, it will now be taxed exactly like mutual funds.
Short term, long term, capital gains, everything.
The good news?
Your old ULIPs (before Feb 2021) are untouched. Do not rush to close them.
Partial withdrawals?
You must calculate gains on a FIFO basis (first-in, first-out).
Keep your statements from day one. Your CA will thank you.
What about TDS?
For residents: 2% on the income component beyond Rs 1 lakh
For NRIs: 30% flat (or 12.5% if long-term, depending on fund type) under section 195
Traditional Policies: The 2023 Rule That Surprised Everyone
If ULIPs were the first wave, traditional plans faced theirs in 2023. From 1 April 2023, the rule says:
If your total premiums for all traditional policies issued after this date exceed Rs 5 lakh in a year, the maturity becomes taxable.
A few insights that matter:
If you buy one policy with Rs 10 lakh premium, the entire maturity becomes taxable.
If you split it into two policies of Rs 5 lakh each, one stays exempt, one becomes taxable.
The law allows aggregation but not proportionate exemption within the same policy.
In short: splitting policies smartly matters.
Staggered Payouts: What If Your Policy Pays Over Many Years?
Many policies today pay in instalments rather than a lump sum. If the policy itself is taxable:
Each year’s payout is taxed on the income portion.
You must segregate principal and gain.
Premium paid over years is deducted proportionately.
The math may not be fun, but ignoring it can be expensive.
Key Takeaways You Should Not Ignore
Old policies have value, both sentimental and tax-related. Do not close them blindly.
For new insurance, check premium-to-sum-assured ratios first, returns later.
ULIPs bought after 1 Feb 2021 with premiums above Rs 2.5 lakh are taxable.
Traditional plans after 1 April 2023 crossing Rs 5 lakh annual premium per person lose exemptions.
Smart structuring matters, splitting policies can keep exemptions alive.
Documentation is your best friend for ULIPs and partial withdrawals.
NRIs must watch out for heavier TDS and more complex calculations.
Final Thought
Insurance remains essential, especially for protection and long-term planning. But in today’s landscape, understanding tax impact is just as important as understanding benefits. Before signing your next policy or surrendering an old one, take a step back and ask: “Is this tax-efficient?”
Financial decisions should be clear, not confusing. And with the right knowledge, they can be.