Section 194DA of the Income Tax Act: Tax Deduction on Life Insurance Policy Payouts

This section mandates tax deductions on the proceeds from life insurance policies under certain conditions. In this blog, we’ll explain everything you need about Section 194DA of the Income Tax Act, including its applicability, rates, exemptions, and important considerations.

What is Section 194DA of the Income Tax Act?

Section 194DA of the Income Tax Act, of 1961 requires insurers to deduct tax at source (TDS) on payouts from life insurance policies. This tax deduction applies when the sum received by the policyholder is not exempt from taxation under Section 10(10D) of the Income Tax Act. The TDS is applicable on the maturity proceeds, including bonus, of life insurance policies that don’t meet specific exemption criteria.

Purpose of Section 194DA

The main purpose of Section 194DA is to ensure that any income earned from life insurance policies that do not qualify for exemption is taxed at source, reducing tax evasion. By imposing TDS, the government ensures taxpayers include this income in their annual tax returns, promoting tax compliance.

Key Provisions of Section 194DA

1. TDS Applicability

   • Non-Exempt Policies: TDS applies to policy payouts that are not eligible for exemption under Section 10(10D). This usually includes policies where the annual premium exceeds 10% of the sum assured for policies issued on or after April 1, 2012, and 20% for policies issued before that date.

   • Exempt Policies: Policies that meet Section 10(10D) criteria are exempt from TDS under Section 194DA. This includes policies with premiums below the specified limits and those issued due to the policyholder's death.

2. TDS Rate

   • Rate of TDS: Effective September 1, 2019, the TDS rate under Section 194DA is 5% on the net income component of the payout. Previously, the TDS was deducted at 1% on the gross payout.

   • Calculation of Net Income: The net income component subtracts the total premiums paid from the payout amount.

3. Threshold Limit

   • Minimum Payout Limit: Section 194DA only applies if the payout amount exceeds INR 1 lakh in a financial year. If the payout amount is below this limit, no TDS is deducted.

4. Impact on Resident and Non-Resident Policyholders

   • Resident Policyholders: The TDS provisions apply to resident individuals and Hindu Undivided Families (HUFs) receiving policy payouts exceeding INR 1 lakh.

   • Non-Resident Policyholders: The provisions for non-residents are different, and the applicable tax rates and regulations may vary according to the Double Taxation Avoidance Agreement (DTAA) with the country of residence.

Exemptions Under Section 10(10D)

For life insurance policy payouts to be exempt from TDS under Section 10(10D), certain conditions must be met:

• Premium Limit: The payout is exempt from TDS if the premium paid does not exceed 10% of the sum assured for policies issued on or after April 1, 2012 (and 20% for policies before that date).

• Death Benefit: Any payout received by a beneficiary due to the death of the insured is fully exempt under Section 10(10D), regardless of premium-to-sum assured ratio.

Policies that meet these criteria are exempt from tax, and thus, no TDS is deducted under Section 194DA.

How to Calculate TDS Under Section 194DA

Let's go over a simple example to understand how much tax will be deducted.

Example Calculation:

Suppose you have a life insurance policy with:

• Total Maturity Payout: INR 2,00,000

• Total Premiums Paid: INR 1,20,000

• Net Income Component: INR 2,00,000 - INR 1,20,000 = INR 80,000

Since the net income component is INR 80,000, TDS at 5% will be calculated as:

• TDS Amount: 5% of 80,000 = INR 4,000

Thus, the TDS amount of INR 4,000 will be deducted by the insurance company before making the payout.

Important Considerations for Policyholders

1. File Income Tax Returns (ITR) Accurately

   If it's taxable, policyholders must report the income from their life insurance policy payouts in their annual ITR. While TDS is deducted at 5%, policyholders may be in a higher tax bracket and must pay additional tax on this income.

2. Form 15G/15H Submission

   Policyholders without taxable income can submit Form 15G (for individuals below 60) or Form 15H (for senior citizens) to the insurance company. These forms help avoid TDS if their income exceeds the taxable limit, provided they meet specific conditions.

3. Check Eligibility for Section 10(10D) Exemption

   Before buying or claiming on a life insurance policy, check if the policy qualifies for Section 10(10D) exemption. Exempt policies offer tax-free maturity proceeds, whereas non-exempt policies will have TDS under Section 194DA if they exceed the threshold.

Section 194DA of the Income Tax Act requires tax deductions on life insurance payouts above a certain limit, impacting how beneficiaries receive funds. This is important for term and life insurance holders, as term insurance provides straightforward payouts, while life insurance combines protection with savings. Understanding these tax implications helps families make informed financial decisions about their insurance benefits.

Wrapping Up!

Section 194DA of the Income Tax Act mandates tax deduction at source on life insurance policy payouts that do not qualify for exemption under Section 10(10D). Policyholders can better manage their tax obligations and ensure compliance by understanding the applicability, rate, and calculation of TDS under Section 194DA. If your policy payout exceeds INR 1 lakh and doesn’t meet the exemption criteria, it’s crucial to be aware of the TDS deductions and to plan your finances accordingly.

Whether you're a policyholder or planning to buy life insurance, being informed about Section 194DA can help you make smart, tax-efficient decisions.

Note: You should also check the term insurance benefits if you are planning to purchase the term insurance plan.

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