Explained: Impact of new tax regime on traditional life insurance

A penny saved is a penny earned. With just a month left for the current financial year to end, tax planning can help you save on taxes and increase your gross income. Taxpayers across the country are looking to invest in popular tax-saving options. If you’re one of them, here’s an important update for you.

As per recent budget 2023 announcements, traditional life insurance policies above a premium of Rs 5 lacs annually will be taxable from 1st April 2023. But what does it mean for investors? What will be its impact? Let’s break it down for you.

Let’s assume you invest Rs. 12 lacs annually for 5 years. In 10 years, your corpus will increase and become Rs. 1.03 crores. Today, this entire maturity amount will be completely tax-free under section 10(10D). But if you make this same investment after 31st March 2023, you will make only Rs. 86 lac after tax deduction, if you fall in the 30% tax slab. This means you’ll be incurring a loss of Rs. 17 lac.

But wait, there’s some good news. You still have one month to buy a traditional life insurance policy and enjoy tax-free returns of up to 7.5%. A smart investor will use this opportunity to buy a life insurance plan before 31st March 2023, and lock in the benefits for future years.

What is traditional life insurance?

Traditional life insurance provides coverage to policyholders for their entire life. They are an ideal choice for individuals with a low-risk appetite. In case of the inevitable death of the policyholder, the insurance payout is made to the beneficiaries. A mix of insurance and investing, these plans are primarily used for wealth creation, offering a small cover by way of protection. Their key features include:

• Maturity benefit: At the time of maturity, you receive a lump sum amount depending on the amount you have paid as a premium (except for term insurance plan).
   
• Death benefit: If the policyholder passes away, the beneficiary receives the basic sum assured along with the bonus, if any. The death benefit is usually tax-free and can be used to cover funeral expenses, pay off debts, or provide ongoing financial support to the policyholder's dependents.
   
• Premiums: In exchange for the death benefit, the policyholder pays regular premiums to the insurance company. Premiums can be paid monthly, quarterly, semi-annually, or annually, depending on the policy.
   
• Tax benefit: The death benefit payout is usually tax-free, meaning that your beneficiaries won't have to pay taxes on the money received. Additionally, some policies offer tax-deferred growth of the cash value, allowing you to accumulate savings without paying taxes on the gains until you withdraw the funds.
   
• Risk-free nature: Your returns under such plans are risk-free, and you have an idea of how much amount you will receive and when. It helps you plan your future better.
   
• Additional covers: Traditional life insurance policies often offer optional riders that can be added to the policy for an additional cost. Riders can provide additional coverage for specific situations, such as accidental death, disability, or long-term care.