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Life insurance is one of the most powerful tax-saving tools available in India, offering benefits under both Section 80C and Section 10(10D) of the Income Tax Act. Yet, many policyholders unknowingly make critical mistakes that either reduce their tax benefits or create unexpected tax liabilities down the line. Understanding these pitfalls can save you thousands of rupees and prevent unpleasant surprises during tax season.
Mixing Investment and Insurance Without Clear Financial Goals
One of the most common and costly mistakes people make is treating life insurance as a one-size-fits-all solution for both protection and wealth creation – without first defining what they actually need.
The Trap of Combo Products
When anyone presents a Unit Linked Insurance Plan (ULIP) or endowment policy as “the perfect solution for both insurance and investment”, it sounds attractive. Why manage two products when one can do both? However, this convenience often comes at a significant cost.
Here’s what typically happens: You need substantial life cover to protect your family – let’s say ₹1 crore. A term insurance policy from LIC or any other IRDAI-registered life insurer might cost you approximately ₹15,000–20,000 per year for this coverage (illustrative figures; actual premiums vary by age, health, and insurer). Instead, you opt for a ULIP or endowment plan that promises both insurance and returns. To get even ₹25–30 lakh coverage through these plans, you might end up paying ₹1.5–2 lakh annually – which can easily be 8–10 times higher.
The problem? You’re severely underinsured (₹30 lakh vs the ₹1 crore you actually need), and you’re not getting optimal investment returns because insurance and policy charges eat into your fund value.
Tax Implications of Wrong Choices
This mixing creates several specific tax problems that many people overlook.
1. The Sum Assured to Premium Ratio Problem
Many people don’t realize that to qualify for tax-free maturity benefits under Section 10(10D), their policy must maintain specific sum assured to premium ratios:
- Policies issued between 1 April 2003 and 31 March 2012: premium should not exceed 20% of the sum assured.
- Policies issued on or after 1 April 2012: premium should not exceed 10% of the sum assured (15% for specified disability or illness cases).
If this ratio is not maintained, your maturity proceeds can become taxable – negating the tax benefit you thought you were getting. If your policy does not qualify for Section 10(10D) exemption and maturity proceeds are taxable, the insurer may deduct TDS as per prevailing provisions before paying you, and the income gets added to your total income for taxation.
2. The New ₹5 Lakh Aggregate Premium Rule
Here’s a recent change many people miss: for specified traditional savings life insurance policies (excluding term plans and ULIPs) issued on or after 1 April 2023, Section 10(10D) maturity exemption is available only if your aggregate annual premium across all such policies does not exceed ₹5 lakh.
If you cross this limit, maturity proceeds can become taxable, though the death benefit remains tax-exempt. This particularly affects high-net-worth individuals who buy multiple high-premium traditional policies thinking they are building tax-free wealth – they could face a rude shock at maturity.
3. The Coverage Gap Risk
You may claim the entire eligible premium under Section 80C (subject to the overall ₹1.5 lakh annual limit across PPF, EPF, ELSS, tuition fees, home loan principal and life insurance premiums), but because your coverage is inadequate, your family faces a massive protection gap that no tax saving can compensate for if something happens to you.
4. The Surrender Tax Impact
You also lock money into a rigid structure. If you need to surrender the policy early due to financial stress, you not only lose money to surrender charges but may also face tax implications on any gains received, especially where 10(10D) conditions are not met.
Old vs New Tax Regime Mistake
A growing mistake is buying life insurance policies mainly for the Section 80C deduction under the old tax regime, then later shifting to the new tax regime and losing that deduction entirely.
- Under the old tax regime, deductions like 80C, 80D and 80CCC are available, so life insurance premiums can meaningfully reduce taxable income.
- Under the new tax regime (introduced in Budget 2020 and made default from FY 2023–24), most deductions including Section 80C are generally not available, except specific cases like employer NPS under Section 80CCD(2).
The problem: many people continue paying high premiums for savings-cum-insurance policies that they purchased mainly for tax benefits, but after shifting to the new regime they get no deduction while remaining stuck with inadequate cover and suboptimal returns.
The lesson: if you have opted for the new tax regime or are considering it, your life insurance decision should be driven primarily by protection needs, not tax benefits. The tax deduction becomes irrelevant if you cannot claim it.
The Smarter Approach: Separation Strategy
Many financial planners recommend separating insurance and investment for good reason.
For protection:
Buy pure term insurance from LIC or any other IRDAI-registered life insurer. Take adequate coverage (for example, ₹1 crore) for a relatively lower annual premium (illustrative only; actual premiums vary). This helps ensure your family is properly protected. Premiums can qualify for Section 80C deduction if you are in the old tax regime and other conditions are met.
For investment:
Invest the remaining amount (that you might otherwise have paid into a combo policy) in suitable investment vehicles based on your goals:
- Equity mutual funds for long-term wealth creation with SIPs over 10+ years.
- PPF or debt funds for stability and relatively predictable returns.
- NPS for retirement planning with additional tax benefits under Section 80CCD, subject to rules.
An added benefit: certain health or critical illness riders attached to life policies may provide additional tax benefits under Section 80D (within 80D limits), which many people overlook – this should always be confirmed with a tax professional.
Define Your Goals First
Before buying any insurance‑cum‑investment product, ask yourself these questions:
What is my primary need?
If it is protection, term insurance is usually the most direct answer. If it is retirement corpus, dedicated retirement plans, NPS and other long-term investments may work better. If it is your child’s education, a combination of term insurance (to protect the goal if you are not around) and mutual fund SIPs (to build the corpus) is typically more efficient.
Can I afford adequate life cover with this product?
If a high annual premium gives you only a fraction of the coverage you need, it is likely the wrong product regardless of its investment features.
What are the tax implications at maturity?
Get clarity on whether your maturity amount will be tax-free. Verify both the sum assured to premium ratio and the ₹5 lakh aggregate premium rule for specified policies issued on or after 1 April 2023.
Whether you choose LIC or any other IRDAI-registered life insurer, the key is to match product type to your actual need and tax situation, rather than to marketing labels.
Relying Only on Employer Group Cover
Many salaried individuals make another related mistake: they depend entirely on employer-provided group life cover (typically a few times annual salary) and buy only small traditional policies for 80C tax benefits.
The risk? If you change jobs, take a career break, or start your own business, your family could suddenly be left severely under‑insured. Employer cover is a benefit, not a permanent solution. You need your own adequate term insurance that stays with you regardless of employment status.
Not Reviewing After Life Changes
Another common mistake is buying a policy once and never reviewing it, even after major life changes like salary hikes, new loans (home or car), marriage, or having children.
Your insurance needs and tax planning strategy should evolve with your life. That ₹25 lakh policy you bought at age 28 may be woefully inadequate at age 38 when you have a home loan, children’s education to fund, and aging parents to support. Similarly, your 80C utilisation pattern may need adjustment as your income and investments grow.
A good practice is to review your life insurance coverage and tax planning at least once every 2–3 years, or after any major life event.
The Bottom Line
Mixing insurance and investment is not inherently wrong – it is doing so without clarity about your goals, tax implications and the old vs new regime impact that causes problems. If you are buying a ULIP or endowment plan, it should be after you have secured adequate term insurance coverage separately and understood the key tax rules. Think of combo products as additions to your portfolio, not replacements for proper protection.
Remember: total Section 80C deduction is capped at ₹1.5 lakh per year across all eligible investments, and this benefit is available only if you are in the old tax regime. Premiums paid to LIC and other IRDAI-registered life insurers can qualify under Section 80C, subject to this overall limit and applicable conditions.
Most importantly, tax benefits should be viewed as a bonus, not the primary reason for buying life insurance. Protection comes first, tax savings come second. Choose your life insurance based on a proper needs analysis and suitability assessment, not just for tax deductions, and you will avoid some of the most expensive mistakes in personal finance.
Disclaimer: Tax rules, limits, ratio requirements and interpretations can change with each Budget and Income Tax Act amendment. This article is for general educational purposes only and should not be considered as tax, legal or investment advice. The premium amounts and coverage figures mentioned are illustrative examples only and will vary based on individual circumstances, age, health, insurer and policy features. Please confirm the latest provisions of the Income Tax Act, verify current policy terms with insurers, and consult a qualified tax professional and certified financial advisor before making any life insurance or investment decisions.