The Central Board of Direct Taxes (CBDT) issued new guidelines on how tax-exempted maturity amount from a life insurance policy will be calculated in a financial year if the premium paid exceeds a specified level. As per the new guidelines, the maturity amount from life insurance policies bought on or after April 1, 2023, will not be fully tax-exempt.

These new guidelines have come after Budget 2023 made the life insurance maturity amount taxable if the premium paid in a financial year exceeds Rs 5 lakh. These guidelines will be applicable to all life insurance policies except for unit-linked insurance policies (ULIPs).

It is important to note that proceeds from ULIPs are taxable from February 1, 2022, if the premium paid exceeds Rs 2.5 lakh in a financial year.

The new CBDT guidelines are issued via a circular and notification dated August 16, 2023.

What does the CBDT circular say?

As mentioned above, the new CBDT guidelines will be applicable for life insurance policies issued on or after April 1, 2023. Hence, for the life insurance policies issued till March 31, 2023, the maturity proceeds will continue to be tax-exempt irrespective of the amount of premium paid during the policy term.

Naveen Wadhwa, chartered accountant and Vice-President, Taxmann.com says, "It is important to note that maturity proceeds from the life insurance policy (issued on or before March 31, 2023) will not be considered in FY 2023-24 and future financial years to calculate the tax-exempt amount. To calculate the tax exemption on life insurance proceeds, only those issued on or after April 1, 2023, will be considered."

According to the CBDT circular, proceeds from the life insurance policy will be taxable if it meets the following criteria:

a) For one life insurance policy: Money received from a life insurance policy will be taxable if the premium paid in previous years during policy terms exceeds Rs 5 lakh.

b) For multiple life insurance policies: Money received from different life insurance policies will be taxable if the aggregate premium paid in previous years during policy terms exceeds Rs 5 lakh.

Wadhwa says, "During the policy term if an individual switches the mode of premium payment say, from annual to semi-annual/ quarterly or vice-versa which leads to premium paid exceeding Rs 5 lakh, then the maturity proceeds of the life insurance policy will become taxable in the hands of an individual."

Do note that the taxability rules above will not be applicable in case of the death of the policyholder, irrespective of the premium paid. The taxable amount will be taxed under the head 'Income from other sources'.

How tax-exempt portion from life insurance policies will be calculated

Wadhwa says, "The CBDT guidelines has clarified that individuals can choose any life insurance policies (whose aggregate premium exceeds Rs 5 lakh) to claim tax exemption. Hence, an individual is allowed to choose the life insurance policies with higher maturity yield for tax exemption and pay taxes on those whose maturity amount is less."

The CBDT, in its circular, has given various examples regarding how tax-exemption of life insurance proceeds will be calculated if the premium paid in any of the previous years during the policy term exceeds Rs 5 lakh. Here are some of the examples from the CBDT circular.

From the table above, it can be seen that the maturity proceeds from life insurance policy X will be exempt as the policy was issued before April 1, 2023. Other life insurance policies were issued on April 1, 2023. Here an individual will be required to calculate the tax-exempt portion.

The maturity proceeds from A and B life insurance policies will be tax-exempt. This is because the aggregate annual premium of both policies does not exceed Rs 5 lakh in a financial year. 

In FY 2033-24, the maturity proceeds from X life insurance policy will be tax-exempt. This is because the annual premium does not exceed Rs 5 lakh. However, for the rest of the insurance policies (A, B and C), the maturity proceeds will be taxable. This is because the aggregate annual premium of all four policies exceeds Rs 5 lakh during the policy term FY 2023-24 and FY 2033-24.

The circular has further clarified that the annual premium will be considered exclusive of the GST paid. The new CBDT guidelines on the taxability of life insurance proceeds will not be applicable to term life insurance policies. This is because the amount is payable to the nominee in case of the death of the policyholder and no amount is paid to the policyholder if he/she survives the policy term.

What will be the income tax rate?

Wadhwa says, "The maturity proceeds will be taxable as per the income tax slab rates applicable to an individual's income."