Are You Buying Insurance To Save Tax?

There is a general misconception that buying insurance is an effective way to save tax. While insurance premiums are of course eligible for tax deduction, they are in no way instruments for tax savings. Rather, the objective of buying insurance has to be very clear – availing of financial protection during times of emergency

In this era of rising inflation, financial planning plays a very crucial role. Just as you are required to eat healthy to remain physically fit, similarly you need to have an adequate financial plan for being financially fit. Typically, in a very traditional way there are four basic needs of an individual to survive, namely, food, clothing, shelter and education. However, ideally there should be five basic needs of an individual which should also comprise planning of finances as none of the conventional basic needs can be fulfilled without basic financial planning. Financial planning is a mix of investment planning, insurance planning, retirement planning and tax planning – each equally important. Generally, insurance planning is clubbed with tax planning – a very common mistake!

Risk Management or Tax Savings

What is the main purpose of insurance: protection against risk or tax-saving? The answer is to provide protection against risk. However, many individuals look at insurance as a tax-saving instrument. Nevertheless, the core objective of insurance is protection against a particular risk and not tax-saving. An individual gets tax benefits by investing in life insurance policies, health insurance policies and pension plans. But the main objective of a life insurance policy is to financially protect the dependents of the insured person. On the same lines, a health insurance policy protects an individual financially in the world of rising healthcare costs.

This is absolutely essential in case a person gets hit by any unfortunate health condition. It also provides a cushion for critical illness. Lastly, pension plans are also known as annuity plans which are similar to life insurance policies. However, life insurance is intended to take care of the family following your death, while a pension plan looks to ensure a financially sound future for yourself and your family with a steady mode of income when you survive and live through your retirement years. Let’s have look at the tax benefits one gets after buying any of the above mentioned insurance policies.

Life Insurance Policy

A life insurance policy is primarily an insurance policy to secure the future of the family in case of the unfortunate demise of a breadwinner. As this is a necessity of every individual’s life, life insurance premiums are deductible and come along with tax benefit under Section 80 C of Income Tax Act, 1961 up to a maximum of ₹ 1.5 lakhs. You can have any type of life insurance policy, be it term insurance policy, endowment policy, ULIP or money-back policy, which allows you to save tax. This tax deduction is subject to restrictions on amount of deduction with respect to the policy’s capital sum assured.

This means that deduction is restricted to 20 per cent of the capital sum assured with respect to policies issued on or before March 31, 2012 and 10 per cent in case of policies issued on or after April 1, 2012. In case of policy taken on or after April 1, 2013 in the name of any person suffering from disability or severe disability referred to in Section 80 U or suffering from disease or ailment as stated in Section 80 DDB, the limit will be 15 per cent of the capital sum assured. Moreover, the proceeds received upon the death of the policyholder or upon maturity on policy are tax-free under Section 10 (10 D).

Health Insurance Policy

Health insurance policy is another important instrument which an individual should include in his insurance portfolio given the rising healthcare and hospitalisation costs which also covers critical illnesses to some extent. On the health insurance premiums paid you can avail tax benefit under section 80 D of Income Tax Act, 1961. The tax benefits are as follows:

1) Tax deductions under Section 80 D for individual and spouse:

◼ Individual or spouse less than 60 years of age – ₹ 25,000
◼ Individual or spouse of 60 years or more age – ₹ 50,000

2) Additional deductions for parent’s premium:

◼ Parents aged 60 years and less – ₹ 25,000
◼ Parents aged 60 years or more – ₹ 50,000.

Pension Plans

While life and health insurance work during the most crucial loopholes in the financial security of your family in times of uncertain mishaps, investing in pension plans will further add to the security blanket. The payment of contribution to a pension plan is deductible under Section 80 CCC of Income Tax Act, 1961 up to ₹ 1.5 lakhs. To claim this tax benefit, the individual must have made payments to receive pension from a fund which is referred to under Section 10 (23 AAB). The provisions of Section 10 (23 AAB) are basically linked with Section 80 CCC. It relates to the income earned from a fund that has been set up by a recognised insurer, including the LIC.

Agreeing to the point that these policies have a lot of tax benefits, they aren’t created for the purpose of tax savings. These act as a backup fund ensuring security in case of unexpected events ensuring financial safety to the individual. These instruments don’t have a significant return and are neither designed to work that way. They essentially are made in a way that it helps you financially in a crisis. Using these as tax-saving instruments might save some amount of tax but could help you the least when required and may cost you way more than you actually require. Rather, buying these for a designated purpose of health and financial safety will help you to utilise the most out of these instruments.

There are other instruments that can help you save taxes under Section 80 C such as PPF, ELSS, NSC, etc. which will deliver you optimal returns. Since many expenses and investment instruments are eligible for deduction under Section 80 C which might use up your limit of ₹ 1.5 lakhs, you won’t benefit from buying insurance for the purpose of tax-saving. Instead you will end up paying a higher premium. A good insurance policy will help make sure that in case of a medical emergency you don’t spend a huge sum and will also help you in keeping your savings and investments safe. Hence, it is suggested that one should buy an insurance policy considering what benefits it has to offer as a policy rather than a tax-saving instrument.

Similarly, pension policies need to be chosen considering your spending and goals post retirement. Not only that but they should also ensure that you battle the inflation rates that vary with time. An individual should always make sure that he adequately plans for his insurance portfolio as excess as well as shortage of insurance policy might lead to adverse financial situations. To reiterate, the sole reason behind purchasing an insurance policy should be to protect yourself financially against risks you might face in the future and not for the purpose of saving the taxes. The biggest drawback of buying insurance for the purpose of tax-saving is paying higher premium when you are not in need of such an insurance cover.