Tax Benefits & Financial Planning
How income tax treats life insurance under the Income-tax Act, 2025: the deduction for premiums, the exemption for policy proceeds and its premium tests, tax deducted at source on payouts, and which benefits exist only under the old tax regime.
A new Act with new section numbers
The Income-tax Act, 2025 replaced the 1961 Act from 1 April 2026 and renumbered its sections; the old numbers are shown here in brackets. Two benefits need to be kept apart: a deduction reduces taxable income for premiums paid, while an exemption keeps money received from a policy out of taxable income.
The deduction for premiums
Section 123 (old section 80C) allows a combined deduction of up to ₹1.5 lakh a year for the items listed in Schedule XV, which include life insurance premiums, PPF, EPF and ELSS. For a policy issued from 1 April 2012, a life premium counts only up to 10% of the sum assured; for policies issued up to 31 March 2012 the limit is 20%.
Section 124(3) (old section 80CCD(1B)) gives a further deduction of up to ₹50,000 for contributions to the National Pension System, over and above the ₹1.5 lakh, so the two can reach ₹2 lakh. Health insurance premiums are dealt with separately in section 126 (old section 80D).
All three deductions are available only under the old tax regime. The new regime, the default under section 202, does not allow them.
The exemption for proceeds
Section 11 read with Schedule II (old section 10(10D)) exempts life-policy proceeds, including bonus. Death proceeds are exempt whatever the amount or the premium; the one exception is a keyman policy, whose proceeds are excluded from the exemption.
Maturity proceeds must pass premium tests. For a policy issued from 1 April 2012 the yearly premium must not exceed 10% of the sum assured, or 15% for a policy issued from 1 April 2013 on the life of a person with a disability or specified illness. In addition, the exemption is lost where the aggregate yearly premium exceeds ₹2.5 lakh on ULIPs issued from 1 February 2021, or ₹5 lakh on other policies issued from 1 April 2023.
Where a ULIP fails the ₹2.5 lakh test, the gain on maturity is taxed as capital gains, at a rate that depends on how long the units were held. The 10% rate with a ₹1 lakh exemption quoted in older material no longer applies.
Tax deducted at source
Where a payout is not exempt, the insurer deducts tax at source under section 393(1) (old section 194DA) at 2% of the payout less the premiums paid. Nothing is deducted if the payments in the year are below ₹1 lakh or the payout is exempt. The rate was 5% until 30 September 2024.
Rules at a glance
Which receipts are exempt?
Illustration: four payouts arrive, three to one family and one to a company. A term plan pays a death benefit of ₹5 crore to the nominee: exempt, because death proceeds are exempt whatever the amount. A 2015 endowment policy whose premium is above 10% of the sum assured matures: not exempt.
A ULIP issued in 2022 with a yearly premium above ₹2.5 lakh matures: not exempt, and the gain is taxed as capital gains. A company receives the proceeds of a keyman policy: not exempt, because keyman policies are excluded.
The 10% test and TDS on one policy
- Assumptions, for arithmetic only: a policy issued in 2020 with a sum assured of ₹10,00,000 and a yearly premium of ₹1,20,000 for 10 years; maturity payout ₹15,00,000; old tax regime.
- Premium as a share of sum assured = ₹1,20,000 ÷ ₹10,00,000 = 12%, which is above 10%.
- Premium counted for the section 123 deduction each year = 10% × ₹10,00,000 = ₹1,00,000, not ₹1,20,000. For the same reason the maturity payout is not exempt.
- Premiums paid = 10 × ₹1,20,000 = ₹12,00,000. Payout less premiums = ₹15,00,000 − ₹12,00,000 = ₹3,00,000.
- TDS = 2% × ₹3,00,000 = ₹6,000.
Result. Only ₹1,00,000 of each year's premium counts for deduction, the maturity payout is not exempt, and the insurer deducts ₹6,000 at source. The payout figure is assumed, not a projection.
Key points
- Section 123 allows up to ₹1.5 lakh for life premiums and other Schedule XV items, under the old regime only.
- Section 11 read with Schedule II exempts proceeds; death proceeds are exempt except under keyman policies.
- Maturity proceeds lose the exemption above ₹2.5 lakh yearly premium on ULIPs from 1 February 2021 and ₹5 lakh on other policies from 1 April 2023.
- TDS on a non-exempt payout is 2% of the payout less premiums paid.
Common misunderstandings
- A deduction and an exemption are not the same: sections 123 and 126 concern premiums paid, section 11 concerns money received.
- The premium tests do not affect a death claim: death proceeds are exempt whatever the premium, except under keyman policies.
- The ₹2.5 lakh ULIP limit is not per policy: it is the aggregate yearly premium across ULIPs issued from 1 February 2021.
Questions people ask
Is a maturity amount always tax-free?
No. It is exempt only if the premium tests are met.
If the premium is above 10% of the sum assured, is the whole deduction lost?
No. The premium still counts for the section 123 deduction, but only up to 10% of the sum assured.
Do life premiums reduce tax under the new regime?
No. The new regime does not allow the section 123 deduction, so life premiums, PPF and ELSS earn no deduction there.
What this lesson relies on
- Income-tax Act, 2025 — sections 11, 123, 124, 126, 202 and 393(1); Schedule II and Schedule XV
- Income-tax Act, 1961 (replaced from 1 April 2026) — sections 10(10D), 80C, 80CCD(1B), 80D and 194DA, for the old numbering
This lesson was reviewed independently against these sources on 8 October 2026. Rules change: check the current regulation, scheme document or policy wording before relying on any figure. This is education, not advice.