Section 11 (Sch. II), Income-tax Act 2025: When a life-insurance payout is tax-free, and when it is not

What changed when Section 10(10D) became a Schedule II entry?

The rule kept its substance and changed its address. The 1961 Act carried the life-insurance exemption as Section 10(10D). The Income-tax Act 2025 has no Section 10 at all: the exemptions that used to live there move into schedules. The life-insurance exemption is now Serial No. 2 of Schedule II, read with Section 11, the section that says nothing listed in Schedule II is included in your total income.

Two taxing rules that used to hang off Section 10(10D) move with it. When a non-ULIP policy is not exempt, the payout is income from other sources under Section 92(2)(l) (the old Section 56(2)(xiii)). When a ULIP is not exempt, its gain is capital gains. So the single old clause now reads across three homes: the exemption in Schedule II, the other-sources charge in Section 92, and the capital-gains rules for a ULIP. The tests that decide which one applies did not change.

The successor location (Schedule II, Serial No. 2, read with Section 11, "Income not to be included in total income") and the other-sources charge (Section 92(2)(l)) are cross-checked against published copies of the enacted Act.†

When is a life-insurance payout completely tax-free?

Two payouts are the easy cases. A death benefit, the sum your nominee receives when the life insured dies, is exempt in every case: no premium test, no cap and no policy-type condition touches it. And any policy issued before 1 April 2003 pays out tax-free on maturity too, because the premium conditions only start with policies issued from that date.

Everything else, a maturity payout, a survival benefit, or money you get on surrendering the policy, is tax-free only if the policy clears two hurdles: the premium-to-sum-assured limit for its issue date, and, for newer policies, an aggregate-premium cap. Miss either and the payout becomes taxable. The decision path above runs the tests in order.

The 10% rule: premium measured against the sum assured

The oldest test compares the yearly premium with the sum assured. The point is to separate real insurance from an investment dressed up as a policy: if you pay a large premium for a small cover, the law treats the maturity as a return on investment, not insurance, and taxes it.

The ceiling depends on when the policy was issued, and the issue date fixes it for life, so an older policy keeps its more generous limit. If the premium in any single year of the policy crosses the ceiling, the whole maturity is taxable, not just the excess.

The premium counted for the test excludes any premium for accident or disability riders, so it is the base life-cover premium that is measured against the sum assured. A single-premium policy almost always fails this test, because one year's premium dwarfs 10% of the cover.†

The two aggregate-premium caps: ₹2.5 lakh and ₹5 lakh

Budget 2021 and Budget 2023 added a second gate, aimed at high-value policies used as tax-free investment wrappers. This one looks at the total premium across your policies, not the premium-to-cover ratio, and it splits by policy type.

For unit-linked insurance plans (ULIPs) issued on or after 1 February 2021, add up the yearly premium on all such ULIPs. If that total crosses ₹2,50,000 in any year of the term, the ULIP loses the exemption and its gain is taxed as capital gains. For any other policy, a traditional endowment or money-back plan, issued on or after 1 April 2023, add up the yearly premium on all such policies; above ₹5,00,000 the maturity loses the exemption and is taxed as income from other sources.

Both caps are aggregate and tested year by year: it is the sum of premiums across the relevant policies in a single year that matters, and crossing the line in even one year taints the payout. A death benefit is exempt from these caps too. Where you hold several policies, CBDT Circular 15/2023 lets you choose which policies to keep inside the ₹5 lakh exempt bucket, so the exemption is not simply lost on all of them at once.

How a non-exempt payout is actually taxed

A taxable payout is not taxed on the whole amount. In every case the tax falls on the income part: the money you receive minus the premiums you paid over the years. What differs is the head of income and the rate.

A non-exempt ULIP is treated like a mutual fund. If it is equity-oriented and you held it more than 12 months, the gain is long-term capital gains under Section 198 (the old Section 112A): 12.5% on the gain above the ₹1.25 lakh yearly exemption. Held 12 months or less, it is short-term under Section 196 (old 111A) at 20%. A ULIP that is not equity-oriented follows the other capital-gains rates.

A non-exempt traditional policy is income from other sources under Section 92(2)(l). The income, payout minus premiums, is added to your total income and taxed at your slab rate, so a 30% taxpayer pays 30% plus cess on it. There is no ₹1.25 lakh exemption and no special rate here; it stacks on top of your salary or business income.

The taxable amount is the sum received less the premiums paid, worked out under the prescribed rule; rider and any tax components are handled by that rule.†

TDS on a taxable payout: the old Section 194DA

When a payout is not exempt, the insurer withholds tax before paying you. The rule is the old Section 194DA, which sits as a payment code in the omnibus TDS section (Section 393) of the 2025 Act. It bites when the total sum paid to you under the policy in a year is ₹1,00,000 or more.

The rate is 2% of the income part of the payout, not 2% of the whole amount. Budget 2024 cut this rate from 5% to 2% with effect from 1 October 2024. The 2% is only a withholding: your final tax depends on the head and rate above, and you claim the amount already deducted as credit when you file. If your PAN is not on record with the insurer, the rate jumps to 20%.

The ₹1,00,000 threshold, the 2% rate (5% before 1 October 2024) and the withholding on the income component carry over from Section 194DA; under the 2025 Act the deduction sits as a payment code in Section 393.†

Surrender, partial withdrawal and paid-up policies

Surrendering a policy is taxed by the same tests as a maturity. The surrender value is a sum received under the policy, so it is exempt if the policy passed the premium tests and taxable if it did not, on the surrender value minus the premiums paid. A ULIP surrender above the ₹2.5 lakh cap is capital gains; a traditional policy's surrender above its limits is other income.

There is a second sting for old-regime taxpayers who claimed the premium as a deduction. If you claimed the premium under Section 123 (the old Section 80C) and then surrender a single-premium policy within two years, or a regular policy before paying two full years of premiums, those past deductions are reversed and added back to your income. So an early exit can both tax the payout and undo the deduction.

How you receive the money and report it

An exempt payout needs no tax entry, but it is worth recording. Exempt life-insurance receipts are reported under exempt income in your return, and large credits show up in your Annual Information Statement (AIS), so a big tax-free maturity that you leave off the return can draw a query even though no tax is due.

A taxable payout must be offered to tax under the right head: capital gains for a ULIP, income from other sources for a traditional policy. Match the figure to the TDS already deducted, which appears in your Form 26AS and AIS against the insurer, and claim that TDS as credit. Reconcile the two before filing; a mismatch on an insurance or securities credit is a common trigger for a notice.

How to keep a life-insurance payout tax-free

The controllable lever is the premium-to-cover ratio. To keep a policy issued today inside the exemption, keep the yearly premium within 10% of the sum assured: on a ₹10,00,000 cover, that means a premium at or below ₹1,00,000 a year. Buy the cover first and size the premium to it, not the other way round. A term plan, which is pure cover with a very high sum assured for a small premium, clears the 10% test comfortably, and its death benefit is exempt in any case.

If you invest through insurance, watch the two caps. Keep the total yearly premium across your ULIPs at or below ₹2,50,000, and across your traditional plans at or below ₹5,00,000, to stay exempt. A couple can hold policies separately so each uses their own cap. If you are already over a cap, the payout is taxable anyway, so compare it honestly with a plain mutual fund or deposit: a high-premium ULIP taxed as equity at 12.5% is often no better than the fund it competes with once you strip out the exemption.

For a payout you know will be taxable, remember only the income part is taxed and 2% is withheld, not the whole sum. A ₹9,00,000 maturity built on ₹7,20,000 of premiums is taxed on ₹1,80,000, which is ₹56,160 at the 30% slab, with ₹3,600 already deducted as TDS. Knowing that in advance stops the withholding coming as a surprise and lets you set the tax aside.

Worked examples

Section 11 (Sch. II) FAQs