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The proposed Direct Taxes Code (DTC), which comes into effect from 1 April 2012, has laid down very stiff conditions for the deduction of the premium from the taxable income and the exemption for income from insurance policies.
- A major game changer for life insurance is that the tax deduction limit will get reduced from the present Rs. 1 lakh a year to only Rs. 50,000 a year under the DTC. That’s not all. This Rs. 50,000 limit would also include the amount paid for tuition fees of children as well as medical insurance. Hence, there won’t be too much head room left for a big premium paid on an insurance policy.
- One of the key insurance-related provisions of the DTC is that a policy will not be eligible for tax deduction if it offers a life cover of less than 20 times the annual premium. This means if the premium of an endowment insurance policy or a Ulip is Rs. 20,000, it should offer a life cover of at least Rs. 4 lakh to be eligible for tax deduction in the coming years. If this condition is not met, not only will the premium lose tax benefits, but even the income accruing from the policy will be taxable.
- Right now, any income from insurance is tax-free except the premature surrender of a pension plan or a Ulip before five years. But under the DTC, withdrawals from a Ulip will attract capital gains tax on the basis of the holding tenure.
If you still want to buy an insurance policy to save tax, make sure that the life cover it offers is big enough. This would be possible if you take long-term plans (at least 20 years). Your agent might try to dissuade you from opting for a higher risk cover in your Ulip. He would point out that a higher deduction for mortality charges would reduce the funds available for investment. Don’t let that make you opt for a plan that might lose all tax benefits two years from now.