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Tax Exemptions vs Tax Deductions What’s the difference?

  2/8/23 7:10 AM

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At their core, all life insurance insurance plans, from a term insurance plan to a ULIP, offer life coverage to you in return for a premium payment throughout a specific tenure. In case you meet an untimely demise during the policy term, the insurance company pays a lump sum amount to your nominees or beneficiaries. This makes sure that your loved ones are financially secure in your absence.

In addition to this essential feature, life insurance policies have become popular tax-saving instruments in the recent past, mainly due to the tax benefits they offer under Sections 80C and 10(10D) of the Income Tax Act of 1961. If you have also opted for a life insurance policy, like term insurance, for its tax benefits, then these two terms are crucial to understand:

●  Tax Deductions

●  Tax Exemptions

These two terms assume great importance in the current scenario, chiefly because the end of the financial year is fast approaching, and tax planning is paramount.

You know that there are tax benefits available for term insurance policies and other life insurance policies that offer coverage to policyholders with added benefits. Then there are additional tax benefits available for policies with critical illness riders and other add-ons. Of course, you should include health insurance policies and other plans like endowment plans, child plans, and ULIPs (unit-linked insurance plans). But are these benefits tax deductions or exemptions? Many of us make the mistake of confusing these two terms for the same thing. In this article, let us understand the distinction between the two. 

Tax Deductions

Income tax deductions can be availed on gross total income. Certain defined investments and expenditures are eligible for tax breaks. For example, deductions can be claimed for investments in specific mutual funds, student loan interest repayment, and premium payments for medical insurance. This reduces your overall taxable income and, as a result, your tax liability. Certain subsections of Section 80 and Section 24 list the deductions that are allowed under the Income Tax Act of 1961.

Tax Exemptions

Income tax exemptions are granted on specific sources of income rather than on total income. It may also imply that you are exempt from paying taxes on income derived from that source. For example, the death benefit payout from a life insurance policy is exempt from taxation. Section 10 lists all the exemptions available to individuals under the Income Tax Act.

What is the Core Difference Between Tax Deductions and Tax Exemptions?

To understand the difference between deductions and exemptions in detail, here are some points that you should keep in mind:

Point of Comparison

Tax Deductions

Tax Exemptions

Definition

Reduction in taxable income through subtraction of eligible expenses from gross income.

Income that is free from taxes either partially or fully.

Effect on Taxable Income

Reduces taxable income, lowering the tax amount payable.

Exempts specific sources of income from taxes, resulting in no taxes being payable for that portion of income.

Availability

Can be claimed on gross income by eligible taxpayers for specific expenses under various sections of the Income Tax Act.

Applicable to specific sources of income, and eligibility criteria and sections of the Income Tax Act may vary.

Examples

Premium payments for term insurance, ULIPs, investments under Section 80C, health insurance premiums under Section 80D, interest on savings accounts under Section 80TTA, etc.

Life insurance, death benefits, HRA, LTA, agricultural income, etc., under specific sections of the Income Tax Act.

 

These are some of the main points to remember regarding tax exemptions and deductions, particularly when investing in insurance policies and other tax-saving instruments. To take the example of a term insurance plan, the death benefits will be tax-exempted for the nominees under Section 10 (10D), where they need not pay any taxes on the proceeds. Additionally, the premiums paid for the plan are deductible under Section 80C, on the total income of the policyholder, up to a maximum of Rs. 1.5 lakh in a financial year.

This is the core difference that all investors should note. Of course, tax benefits are not the sole factor in deciding which plan you should buy. Make sure you consider the coverage amount, the premium and the tenure of the policy before you add it to your portfolio.

 

Aastha Mestry - Portfolio Manager 

An Author and a Full-Time Portfolio Manager, Aastha has 6 years of experience working in the Insurance Industry with businesses globally. With a profound interest in traveling, Aastha also loves to blog in her free time.

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