You may invest in a term policy to maximize your tax benefits under Section 80C. However, there are scenarios where the Section 80C benefits may reverse, although it depends on a few conditions. Section 80C is usually a preferred tax-saving avenue for taxpayers since it enables deductions up to Rs. 1.5 lakh for taxpayers on premium payments on their life insurance policies. Yet, some scenarios will lead to the reversal of these benefits. Here’s taking a closer look at them below.
When Are Section 80C Tax Benefits Reversed?
Section 80C tax benefits may reverse if the policyholder chooses to terminate the term insurance policy owing to non-payment of the premium amount and does not revive the policy for two years for single-premium policies. In this situation, there will be no allowable deduction under Section 80C according to prevailing regulations.
Simultaneously, the deduction amounts claimed by the taxpayer will be taken as income in the taxpayer’s hands, leading to previous deductions getting reversed. In addition, benefit amounts received from life insurance policies discontinued before completing two years will also be taxed as per the guidelines for Section 80C deductions.
It sometimes happens when people invest blindly in investment and insurance offerings as immediate tax-saving options before the end of the financial year. After that, they stop paying the premiums since they feel their purpose has been taken care of. Yet, know that conventional insurance policies may require a long-term commitment in terms of investment, and taxpayers may suffer sizable losses if the policies are surrendered in their first few years. For situations where the policy discontinues after a year, the insurance company will deduct the entire premium amount. In scenarios where policies are surrendered by people after the second or third year, only a percentage of the total premium amount will be paid.
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Some Other Points Worth Noting
Not meeting the conditions of tax deductions will lead to the deductions in earlier years being taken as income for the coming financial year, which is a situation that taxpayers will wish to avoid. The holding period should be at least two years for life insurance policies, while it should be five years for ULIPs or unit-linked insurance plans. Discontinuation or termination of premium payments for ULIPs within five years of policy issuance may lead to the reversal of Section 80C tax benefits claimed previously. Simultaneously, surrendering any pension plan before the completion of premiums for two years will also lead to the tax benefits under Section 80C reversing. The tenure also changes for those working in the Government.
The minimum tenure has not been mentioned under Section 80C though taking Section 80CCD into account means that pension schemes of Government employees should stay fixed for a minimum duration of three years. Deductions claimed earlier may reverse for employees who withdraw from these plans before the conclusion of three years.
The Section 80C deduction is also available for policies where the premium amount is up to 10% of the sum assured. If the premium surpasses 10% of the sum assured, the maturity amount will be taxable in the hands of the policyholder. These are only for policies issued after the 1st of April, 2012. Before this period, the premium had to be a maximum of 20% of the sum assured, exceeding which would lead to the maturity amount being taxable in the insured’s hands.
Even if you withdraw any investment after claiming tax deductions for the same, you should declare it promptly. If you do not declare it and your ITR comes under scrutiny, further proof will be necessary. If the deduction is withdrawn, it will be taxed as income from other sources, with taxability as per the prevailing slab rate. If there is any scrutiny of the returns and the policyholder is asked about investments, then extra interest, tax, and penalty costs may apply. It could zoom to 50-200% of the tax amount.
You should keep all these clauses in mind and avoid premature withdrawals if you can help it. Do not blindly rush into investing in term plans. Instead, use a term plan calculator and work out the payable premium, policy tenure, and other factors before signing the dotted line.
