Taxable Life Insurance Policy Bonuses

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Taxable Life Insurance Policy Bonuses

Life insurance bonuses are no longer automatically tax-free in India. For policies issued on or after 1 April 2023 with aggregate annual premiums exceeding ₹5 lakh, and for ULIPs issued on or after 1 February 2021 where aggregate premiums cross ₹2.5 lakh annually, the Section 10(10D) exemption is denied and maturity proceeds — including bonuses — become taxable. Death benefits remain exempt across all policy types. This guide maps every scenario, with worked Rs. examples, correct ITR reporting steps, and the specific mistakes that trigger tax notices.

Why the Rules Changed and What Exactly Changed

For most of India's income-tax history, Section 10(10D) of the Income Tax Act 1961 offered a near-complete exemption on any sum received under a life insurance policy — principal, bonus, fund growth, everything. The logic was sound: encourage long-term household savings and provide risk cover. The problem was that high-net-worth individuals were routing large lump sums into high-premium endowment and ULIP policies purely to convert investment returns into tax-free income, bypassing capital gains and surcharge entirely.

The legislature responded in two steps:

1. Finance Act 2021 (effective 1 February 2021): Capped ULIP exemption where aggregate annual premiums across all such policies exceed ₹2.5 lakh.
2. Finance Act 2023 (effective 1 April 2023): Extended a parallel ₹5 lakh aggregate annual premium cap to all non-ULIP life insurance policies (endowment, money-back, whole life).

Union Budget 2026 did not alter these thresholds or the tax rates applicable to insurance proceeds, so the framework for AY 2026-27 and AY 2027-28 is the one consolidated by Finance Act 2023, with the LTCG rate revision brought in by the Finance (No. 2) Act 2024 (effective 23 July 2024) applying to ULIP gains.

Section 10(10D): The Core Exemption and Its Surviving Conditions

Section 10(10D) exempts "any sum received under a life insurance policy, including the sum allocated by way of bonus on such policy." The exemption survives if all of the following conditions are met for the policy in question:

• Premium-to-sum-assured ratio: Annual premium must not exceed 10% of the actual sum assured (15% for policies issued between 1 April 2003 and 31 March 2012; 20% for policies issued before 1 April 2003).
• ULIP aggregate test (policies issued on/after 1 Feb 2021): Aggregate annual premium across all ULIPs of the assessee must not exceed ₹2.5 lakh in any financial year during the policy term.
• Non-ULIP aggregate test (policies issued on/after 1 Apr 2023): Aggregate annual premium across all non-ULIP policies must not exceed ₹5 lakh in any financial year during the policy term.

If the policy fails any applicable condition, the entire receipt — not just the excess — loses exemption. There is no partial exemption. This is the detail most policyholders miss.

Death benefits under clause (d) of Section 10(10D) are explicitly carved out and remain exempt regardless of premium levels or policy type.

ULIP Taxation in 2026: The ₹2.5 Lakh Aggregate Rule

Which ULIPs Are Covered

Only ULIPs issued on or after 1 February 2021 fall under this regime. ULIPs issued before that date — even if premiums are still being paid — retain the old exemption, subject only to the 10% premium-to-sum-assured test.

How the Aggregation Works

The ₹2.5 lakh limit is computed across all ULIPs held by the same individual in the same financial year, not per policy. So if you hold two ULIPs post-February 2021, paying ₹1.5 lakh annual premium on each, your aggregate is ₹3 lakh — both policies fail the test, and maturity proceeds on both are taxable.

Tax Treatment of Taxable ULIP Proceeds

Section 45(1B) brings taxable ULIP proceeds into the capital gains framework. The treatment mirrors equity-oriented mutual funds:

The "cost" for capital gains purposes is the aggregate of premiums paid. Any partial withdrawals already received reduce the cost proportionately.

Worked Example — ULIP Exceeding ₹2.5 Lakh Threshold

Rajesh, a salaried professional, holds two ULIPs:

• ULIP A (issued March 2021): Annual premium ₹1,80,000; maturity value ₹28,00,000; total premiums paid over 10 years ₹18,00,000; held > 12 months.
• ULIP B (issued June 2022): Annual premium ₹1,20,000; maturity value ₹9,50,000; total premiums paid over 6 years ₹7,20,000; held > 12 months.

Aggregate annual premium = ₹3,00,000 > ₹2,50,000 → Both ULIPs lose Section 10(10D) exemption.

For AY 2027-28 (assuming both mature in FY 2026-27):

• ULIP A gain: ₹28,00,000 − ₹18,00,000 = ₹10,00,000
• ULIP B gain: ₹9,50,000 − ₹7,20,000 = ₹2,30,000
• Combined long-term gains: ₹12,30,000
• Exempt slab: ₹1,25,000
• Taxable LTCG: ₹11,05,000 @ 12.5% = ₹1,38,125

Had either ULIP been taken before 1 February 2021, it would retain exemption (assuming the 10% rule passes) and only the post-2021 policy's proceeds would be assessed.

Non-ULIP Policies from 1 April 2023: The ₹5 Lakh Rule

Scope

This rule covers traditional endowment plans, money-back policies, whole life plans, and any other non-ULIP life insurance policy issued on or after 1 April 2023. The mechanism is identical to the ULIP rule: aggregate all qualifying annual premiums paid in a financial year across all such policies held by the assessee.

What Is "Aggregate Annual Premium"?

Only non-ULIP policies issued on or after 1 April 2023 count toward the ₹5 lakh aggregate. Policies issued before that date are excluded from the aggregation, even if they are still in force.

The tax treatment on failure: maturity proceeds (including terminal bonus, reversionary bonus, loyalty additions) are taxable as Income from Other Sources under Section 56. The taxable amount is:

> Taxable income = Sum received − Aggregate premiums paid

No indexation is available. The full income is added to total income and taxed at slab rates.

Worked Example — Endowment Policy Crossing ₹5 Lakh

Priya, a business owner, takes three new endowment policies in FY 2023-24:

• Policy 1: Annual premium ₹2,00,000; sum assured ₹25,00,000
• Policy 2: Annual premium ₹2,00,000; sum assured ₹22,00,000
• Policy 3: Annual premium ₹1,50,000; sum assured ₹18,00,000

Aggregate annual premium = ₹5,50,000 > ₹5,00,000 → All three policies fail the test.

Policy 1 matures in FY 2026-27 paying out ₹35,00,000 (principal + bonuses). Total premiums paid over 15 years = ₹30,00,000.

• Taxable income = ₹35,00,000 − ₹30,00,000 = ₹5,00,000
• Added to slab income; if she is in the 30% bracket: tax = ₹1,50,000 (plus cess)

Note: Even though Policy 1's own annual premium is only ₹2 lakh — well within ₹5 lakh standalone — the aggregation across all three policies triggers the liability.

TDS Under Section 194DA: What the Insurer Deducts

When a taxable life insurance payout crosses ₹1 lakh in a financial year and the policy does not qualify under Section 10(10D), the insurer (Life Insurance Corporation or any other insurer) must deduct TDS at 2% on the income portion — that is, on (sum received − premiums paid), not on the gross payout.

Key mechanics:

• Threshold: TDS triggers only when aggregate payout in the FY exceeds ₹1 lakh.
• Base: TDS is on income, not on the gross amount. For a ₹35 lakh maturity where ₹30 lakh was paid in premiums, TDS is 2% of ₹5 lakh = ₹10,000.
• No PAN: Rate jumps to 20% under Section 206AA.
• For ULIPs under Section 45(1B): TDS under 194DA does not apply. The insurer reports the transaction; the policyholder computes and pays capital gains tax in the return.
• Form 26AS / AIS: The insurer files Form 26Q, and the deduction appears in Form 26AS. Maturity proceeds from life insurance now appear as a distinct line in the AIS (Annual Information Statement), so any under-reporting flags automatically.

Money-Back Policies, Surrender Values, and Keyman Insurance

Money-Back Policy Installments

Survival benefit installments under a money-back policy are treated as part of the maturity proceeds for Section 10(10D) purposes. If the policy satisfies all conditions (including the aggregate premium test), each installment received is exempt. If the policy fails, each installment is taxable in the year it is received. The insurer deducts TDS under 194DA on each installment if the annual aggregate crosses ₹1 lakh.

Surrender Value

Pre-mature surrender receives the same treatment as maturity — exempt if the policy qualifies under Section 10(10D), taxable as Income from Other Sources if it does not. However, for a policy surrendered before the premium-payment period is complete, the 10% premium-to-sum-assured condition must still pass at the time of surrender.

Keyman Insurance

Proceeds from a keyman insurance policy have never been covered by Section 10(10D) — they are taxable in the hands of the recipient (the employer/company) as business income. This position is unchanged in 2026.

Reporting Taxable Insurance Proceeds in the ITR for AY 2027-28

Getting the ITR entry right matters because the AIS already has the data from the insurer. Mismatches generate automated notices under Section 143(1)(a).

For Taxable ULIP Proceeds (Section 45(1B))

1. Open Schedule CG in ITR-2 or ITR-3.
2. Report under "Capital gains from assets other than listed equity/MF units" if STCG, or under the relevant LTCG sub-section.
3. Cost of acquisition = total premiums paid during the policy term (net of any survival benefits already received, if applicable).
4. LTCG above ₹1.25 lakh → taxable at 12.5% without indexation. Fill the LTCG section accordingly.
5. No 194DA TDS to claim here; confirm no TDS was deducted and report accordingly.

For Taxable Non-ULIP Proceeds (Section 56 / Income from Other Sources)

1. Open Schedule OS in ITR-2 or ITR-3.
2. Report the income portion: sum received minus aggregate premiums paid.
3. Cross-check against AIS: the insurer-reported gross amount will appear under "SFT — Life Insurance Maturity Proceeds." The AIS figure is gross; your taxable figure is net of premiums.
4. If TDS was deducted under 194DA: claim credit in Schedule TDS-2, matching TAN of the insurer against Form 26AS.

Documents to Retain

• Original policy bond showing issue date (critical for determining pre/post 2021 or 2023 status)
• All premium payment receipts for the entire policy term
• Surrender/maturity statement from insurer showing breakdown of principal and bonus
• Form 16A / TDS certificate from insurer if 194DA was deducted

Common Mistakes and How to Fix Them

1. Applying the ₹5 lakh test per policy instead of in aggregate. The limit is across all qualifying non-ULIP policies in force in that FY. If you took three policies paying ₹2 lakh each, you crossed ₹5 lakh even though each policy individually is "within limit." Review all policies taken on or after 1 April 2023 and add up their annual premiums now.

2. Assuming death proceeds are also affected. Death benefits are explicitly exempt under Section 10(10D)(d) regardless of premium size, ULIP status, or any other test. Nominees do not pay tax on the sum assured plus accumulated bonus received on death.

3. Ignoring grandfathered policies. A ULIP issued in 2019 is not subject to the ₹2.5 lakh rule — only the premium-to-sum-assured test applies to it. Do not aggregate it with post-2021 ULIPs when computing the threshold.

4. Not providing PAN to the insurer. TDS at 20% (instead of 2%) under Section 206AA is a painful cash-flow hit for policyholders who failed to update their PAN with the insurer. Update your PAN at least one policy year before expected maturity.

5. Reporting gross amount in Schedule OS instead of net income. Section 194DA TDS is deducted on the income portion. If you report gross proceeds in Schedule OS without deducting premiums paid, you drastically overstate income. Always compute: sum received minus total premiums paid = taxable income.

6. Confusing ULIP taxation with equity MF taxation for indexation. ULIP gains under Section 45(1B) do not attract indexation. Unlike debt MFs where some investors still seek indexation arguments, ULIP LTCG is explicitly at 12.5% flat on the gain above ₹1.25 lakh.

7. Forgetting that money-back installments received in prior years may need adjusting. If a money-back policy fails the new ₹5 lakh test, each survival benefit installment received in the current and earlier years (since the policy was issued on/after 1 April 2023) needs to be assessed for any unpaid tax. This can create a bunching problem in the year the test is first failed — get professional advice on whether a revised return or advance tax catch-up is needed.

Planning Strategies to Preserve Section 10(10D) Exemption

These are compliant approaches, not aggressive positions:

• Keep new ULIP premiums at or below ₹2.5 lakh in aggregate. If you want more ULIP exposure, consider whether returns justify losing the exemption, especially now that LTCG @ 12.5% applies.
• For non-ULIP policies, stay below ₹5 lakh aggregate annually. If you have existing high-premium policies issued before 1 April 2023, they do not count toward the aggregate, preserving headroom.
• Use term insurance for pure risk cover. Term policies meet the 10% premium-to-sum-assured test easily (premiums are typically 0.5–1% of sum assured). Their death proceeds are exempt, and since there is no maturity value, the taxability question does not arise.
• Review the premium-to-sum-assured ratio on endowment plans. If annual premium exceeds 10% of sum assured — which can happen on limited-pay endowment plans — the policy fails the basic Section 10(10D) test entirely, irrespective of the ₹5 lakh rule.
• Segment policies across family members. The ₹5 lakh and ₹2.5 lakh tests are per-assessee. A spouse's own policy premiums count against her aggregate, not yours, provided she is the proposer and insured. Gifting premium payments to a spouse and having her take the policy in her name can be a valid planning tool, subject to clubbing provisions — confirm that her income supports the premium independently.

Key Takeaways

• Section 10(10D) exemption survives only if all applicable tests pass — the 10% premium-to-sum-assured ratio and, for newer policies, the ₹2.5 lakh (ULIP) or ₹5 lakh (non-ULIP) aggregate annual premium cap.
• The ₹5 lakh aggregate test applies to non-ULIP policies issued on or after 1 April 2023; failing it makes maturity and bonus proceeds taxable as Income from Other Sources at slab rates.
• Taxable ULIP proceeds fall under capital gains (Section 45(1B)) — long-term gains above ₹1.25 lakh are taxed at 12.5% without indexation under the post-July 2024 regime.
• TDS under Section 194DA is deducted at 2% on the income portion (gross payout minus total premiums paid) when the payout exceeds ₹1 lakh; failure to furnish PAN escalates TDS to 20%.
• Death benefits are always exempt — the new rules affect savings-oriented and investment-linked products only, not pure risk cover.
• Maturity proceeds now appear in the AIS as a separate line item — reporting them incorrectly, or not at all, will generate automated mismatches under Section 143(1).
• Pre-2021 ULIPs and pre-2023 traditional policies are grandfathered and assessed under the old rules — do not mix them into the aggregation calculation for newer policies.