Do beneficiaries pay taxes on life insurance?

Life insurance plans are financial products that aim to lower the impact of uncertainties on your life. A life insurance plan is basically a contract between you and the insurance provider. The basic terms of the contract involve that you pay a premium to the insurance provider regularly. In exchange of this premium, the provider offers life coverage to you. This means that in the case of your death, a beneficiary receives a fixed sum of money known as death benefit.

Who is a beneficiary?

When buying a policy, you will be asked to mention the name of the person you would like to name as your beneficiary. Depending on the policy provider that you select, you might have to mention primary and contingency beneficiaries.

A beneficiary is anyone that you appoint to receive the payout of the insurance policy. Usually, it is someone who is close to you and identifies as your dependent. However, that is not a set rule. You could nominate your spouse, parents, children or even an organization as your beneficiary.

Do beneficiaries pay taxes on life insurance?

Any wealth that you create is considered as an income and you have to pay income tax for it. The tax you need to pay depends on the income you had during the year. The more you earn, the higher tax you would need to pay. You as a policyholder avail certain tax benefits when you opt for an insurance plan that is in line with your needs.

Generally, policyholders are aware of the tax deductions they are entitled to by paying for premiums of their life insurance policy. Under Section 80C of the IT Act, premiums paid towards life insurance policies are eligible for tax deductions.

In case the insured person passes away, their family would receive the benefit of that policy after their demise. Technically, that amount of money is income for the nominated beneficiary. Does that mean they would have to pay tax on it? The simple answer is no. One of the benefits of life insurance is that the payout of the policy is exempt from income tax.

Under Section 10D of the IT Act, the policy payouts, including any bonus, that are paid on maturity, surrender of the policy or on death of the policyholder are tax free for the beneficiary. However, there are certain conditions wherein the payout will be taxable. If the clause states that death benefits need not be paid immediately upon the policyholder’s demise, the provider holds the amount, paying it only after the interest accumulation period is over. The portion of interest earned during this specific period will be taxable.

To conclude…

As a rule, beneficiaries are not liable to pay income tax on the amount they receive as life insurance payouts. The only situation when they have to pay taxes is when the sum assured held by the provider, based on the policyholder’s decision, accumulates interest during a specified period.