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Do Beneficiaries Pay Taxes on Life Insurance?

Dec 11, 2019 | 4 months ago | Read Time: 3 minutes | By iKnowledge Team
Do Beneficiaries Pay Taxes on Life Insurance?

Introduction

Life insurance policies are financial instruments that serve to minimise the financial impact of such uncertainties. A life insurance policy acts as a contract between you, i.e. the policyholder and the insurer – you pay an amount called premium regularly towards the policy and in return, the insurer promises to pay your beneficiaries a death benefit in case of your unfortunate demise. 

Who are the beneficiaries in life insurance?

Under a term insurance contract, the beneficiaries are generally stated on the policy documents. The policyholder/insured person is asked to mention the name of the beneficiary who he or she would like to gift the proceeds of the policy. These are usually the people who you’d identify as your dependents. They are your loved ones who would suffer a huge emotional and financial loss if you were to die. Most often these are your kids, partner, parents, etc. The death benefits from the life insurance policy will help them pay off debts or liabilities, pay for their daily expenses, fund their education etc. 

Do beneficiaries pay taxes on life insurance?

One of the most defining and popular features of life insurance are the tax benefits it carries. 

Usually, a life insurance policy brings you the advantage of deduction of the premium amount for the purpose of income tax calculation. Apart from that, there is a tax exemption on the death benefits received. This sum is fully exempt from Income Tax under Section 10(10D). In other words, the proceeds from the policy are completely tax-free in the hands of the beneficiaries. 

But the question then arises – are there any situations when the beneficiary might have to pay tax still?

One such situation is where the policyholder has chosen not to have the benefit paid out immediately upon death.  In such cases, the amount is held by the insurance company during this period. The beneficiary receives this after a period of interest accumulation. This portion of interest is liable to taxes. Thus, the beneficiary pays tax not on the policy amount received but on the interest that it has since accumulated. 

The other case where taxes enter the picture is in the form of the estate and inheritance tax. Sometimes, the proceeds from the life insurance policy go towards to the estate of the deceased. This happens when either the beneficiary dies before the policyholder does and no other beneficiary is named. It is rare, but in such cases, the proceeds become a part of the legacy, the estate of the deceased. Once the death benefits become a part of the estate, they become subject to estate or inheritance tax. This rarely happens, though, because you are mostly asked to state a primary beneficiary and a contingent beneficiary. 

Conclusion

As a norm, when the beneficiary receives the death benefit under a life insurance policy, they are not supposed to pay any tax on this amount. The death benefits are not counted as taxable income, but any interest that accumulates over it or estate additions because of it is liable to be taxed. 

Read about Sabse Pehle Life Insurance Campaign, an initiative by IRDA to create awareness on the importance of life insurance.


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