Section 194DA Income Tax Act: TDS on Life Insurance Policy Payouts

Life insurance plays an important role in financial planning. It provides the assigned beneficiaries with a financial safety net in case of the policyholder’s untimely death. In addition to their primary purpose of financial protection, certain life insurance products also serve as a long-term savings tool. 

Now, before you invest in a comprehensive life insurance plan that combines protection with long-term wealth creation, you must first understand the various tax implications associated with it. Here is where section 194DA of the Income Tax Act comes into play. Continue reading to learn everything about this section and how life insurance proceeds are taxed under it.        

Know More About How to File TDS Return?           

What Is Section 194DA of the Income Tax Act? 

Introduced in 2014, section 194DA of the Income Tax Act contains provisions that mandate tax deduction at source (TDS) on payments made by certain insurance policies. 194DA was introduced primarily to improve tax compliance, reduce tax evasion, and provide additional tax revenue to the Government of India.

Applicability of Section 194DA of the Income Tax Act

The provisions of section 194DA will apply to the following types of life insurance policies: 

1. Life insurance policies with an income component, including bonuses and loyalty benefits. 
2. Life insurance policies that do not qualify for exemption under section 10(10D) of the Income Tax Act. 
3. Life insurance policies with aggregate payouts exceeding ₹1 lakh in a financial year.

Entity Responsible for Deducting TDS Under Section 194DA of the Income Tax Act 

As per section 194DA of the Income Tax Act, the life insurance company is responsible for deducting TDS from the payments they make to their policyholders during a financial year. Only after the appropriate TDS is deducted must the life insurer transfer the remaining payout to the policyholder.  

What Is the Rate of TDS Deduction Under Section 194DA of the Income Tax Act?

According to section 194DA, the rate at which TDS needs to be deducted is 5% of the income component, including bonuses and loyalty payments, of the life insurance policy payout.

Here is a hypothetical example to help you understand how TDS is deducted under section 194DA. 

Assume you have a life insurance policy that does not qualify for exemption under section 10(10D) of the Income Tax Act. The policy matures in March 2024, and you receive a payout of ₹10 lakh. Over the entire life insurance term, you pay a total premium of ₹7 lakh.

In this case, the net income component of your life insurance plan, including bonuses and loyalty payments, is ₹3 lakh (₹10 lakh – ₹7 lakh). The 194DA TDS rate of 5% is levied on the net income component of ₹3 lakh. 

The life insurance company will deduct TDS of ₹15,000 (5% of ₹3 lakh) and pay the remaining amount of ₹2.85 lakh (₹3,00,000 – ₹15,000) to you.

Budget 2024 Update

The Union Budget 2024 introduced a proposal to reduce the rate of TDS under section 194DA to 2% of the income component of the life insurance policy payout. This reduced TDS rate will come into effect on October 1, 2024.  

What are the Exceptions to Section 194DA of the Income Tax Act?

Although section 194DA seems to cover most insurance policies, there are certain exceptions that you need to know about. Here is a quick overview. 

• Life insurance policies with aggregate payouts of less than ₹1 lakh in a financial year are exempt from 194DA TDS. 
• Life insurance policies and payments that qualify for exemption under section 10(10D) of the Income Tax Act are also exempt from section 194DA. These include the following: 
  • All payments received under section 80DD(3) and section 80DDA(3)  
  • All payments received under Keyman insurance policies
  • All payments received by the beneficiaries on the death of a life insurance policyholder
  • Life insurance policies issued between April 1, 2003, and March 31, 2012, where the premium paid exceeds 20% of the sum assured
  • Life insurance policies issued on or after April 1, 2012, where the premium paid exceeds 10% of the sum assured. 
  • Life insurance policies issued on or after April 1, 2013, where the premium paid exceeds 15% of the sum assured. However, this is only applicable if the policies are purchased by individuals with disabilities and ailments listed under section 80U or section 80DDB. 

What are the Consequences of Non-Compliance With the Provisions of Section 194DA of the Income Tax Act?

If the life insurance company fails to comply with the provisions of section 194DA, they will be subject to the following legal consequences:

• As per section 271C of the Income Tax Act, a penalty equivalent to the amount of TDS that was supposed to be deducted and paid would be levied on the life insurance company.  
• If the life insurance company did not deduct TDS on time, interest at the rate of 1% per month on the amount of TDS that was supposed to be deducted would be levied. The interest will be levied from the date of the supposed TDS deduction to the date of the actual deduction. 
• If the life insurance company deducted TDS but failed to deposit it on time, interest at the rate of 1.5% per month on the amount of TDS that was deducted and not paid would be levied. The interest will be levied from the date of the supposed TDS deposit to the date of the actual deposit. 

Conclusion

By ensuring that the taxable portion of insurance proceeds is subject to TDS, section 194DA of the Income Tax Act promotes tax compliance and reduces the scope for tax evasion. If you are a policyholder or plan to purchase a life insurance policy in the future, keep in mind that there has been a major change in the 194DA TDS rate. 

From October 1, 2024, the rate of TDS would be 2% on the net income component of life insurance policies instead of 5%. This essentially translates to lower taxes and higher payouts. 

Now, if you wish to know just how much TDS is likely to be deducted from your life insurance policy payout, consider using a TDS calculator. The tool can help you accurately determine the amount of TDS that will be deducted and paid on your behalf so that you can plan your finances better.     

FAQs