Employer-Employee Insurance Scheme in India: How It Works and How It Is Taxed

The Short Answer

An employer-employee insurance scheme is an arrangement where a business pays the premium on a life insurance policy covering an employee, usually as a retention benefit or part of a senior employee’s pay package. The death benefit protects the employee’s family; where the plan has a maturity value, that goes to the employee.

There are two quite different ways to set it up. If the employee owns the policy and the employer simply pays the premium, the premium is a taxable perquisite for the employee, and the payout can be tax-free under the normal life insurance rules. If the employer owns the policy on the employee’s life, the tax law treats it as a keyman insurance policy, and the life insurance exemption does not apply. Getting this choice wrong is the most expensive mistake in these schemes.

Who owns the policy decides how it is taxed. Settle that first, and everything else follows.

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Two Structures

How an employer-employee scheme can be structured

	Route A: employee owns the policy	Route B: employer owns the policy
Proposer and policyholder	The employee	The business
Life assured	The employee	The employee
Who pays the premium	The business	The business
Who receives the money	The employee, or their nominee on death	The business, unless and until the policy is assigned to the employee
How the tax law sees it	An ordinary life policy, paid for by the employer	A keyman insurance policy, by definition

Route B surprises many employers. The tax law defines a keyman policy as a life policy taken by a person on the life of someone who is, or was, their employee or is connected with their business. It does not ask whether the employee is “key”. So any policy the business takes out on an employee’s life falls inside that definition, with all the tax consequences explained in our keyman insurance guide.

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Why Employers Use It

Who an employer-employee scheme suits

• Retaining a few senior people. A policy paid for by the business is a visible, long-term benefit, and it can be tied to continued service.
• Topping up thin personal cover. Many mid-career employees are badly underinsured. A scheme closes part of that gap for their families.
• Family-run businesses that want to extend protection to working family members who draw a salary from the business.

For covering a whole workforce cheaply, a scheme of individual policies is usually the wrong tool. A group term life policy covers everyone under one contract, at a far lower cost per person. Individual employer-employee policies make sense for a small number of people, chosen deliberately.

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The Tax Position · Route A

Tax when the employee owns the policy

This is the cleaner route. The Income-tax Act, 2025 has applied from 1 April 2026; earlier section numbers are shown for reference.

Item	Treatment	Income-tax Act, 2025	Earlier (1961 Act)
Premium paid by the employer, for the employee	A perquisite: added to the employee’s taxable salary	Section 17(1)(g)	Section 17(2)(v)
The same premium, for the employer	Part of the employee’s remuneration; generally deductible as business expenditure	Section 34 (general deduction)	Section 37(1)
Death benefit paid to the family	Exempt	Schedule II, Sl. No. 2, read with section 11	Section 10(10D)
Maturity or surrender amount to the employee	Exempt only if the policy meets the premium conditions (below)	Schedule II, Sl. No. 2	Section 10(10D)

For a policy issued on or after 1 April 2023, the maturity exemption has two conditions. First, the annual premium must not exceed 10% of the sum assured, or 15% for policies on the life of a person with a disability or a specified disease. Second, for policies other than ULIPs, the total premium across all such policies taken by the person must not exceed ₹5 lakh a year. For ULIPs the limit is ₹2.5 lakh. A generous employer-paid savings policy can breach these limits, and then the maturity amount becomes taxable. Death benefits are not subject to these premium conditions.

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The Tax Position · Route B

Tax when the employer owns the policy

Because an employer-owned policy on an employee’s life is a keyman policy in law, it follows keyman rules:

• The life insurance exemption does not apply to any sum received under it (Schedule II, Sl. No. 2(c)(ii) of the 2025 Act; formerly Explanation 1 to section 10(10D)).
• Money received by the business is business income (section 26(2)(i); formerly 28(vi)).
• Money received by the employee is taxable as profits in lieu of salary (section 18(1)(c)(iii); formerly 17(3)(ii)).

Some arrangements are designed to have the employer own the policy during the premium-paying years, and then assign it to the employee before maturity. Since 1 April 2014, the definition of a keyman policy expressly includes a policy that has been assigned, which was meant to stop assignment converting it into a tax-free policy. The courts have not been consistent on this. The Madras High Court, in Allu Arvind Babu (2021), held that an assigned keyman policy keeps its character and its proceeds are taxable. Some tribunal benches, relying on an earlier Delhi High Court ruling, have taken the opposite view. That is not a position to plan around. If an assignment-based structure is proposed to you, have a chartered accountant review it before the first premium is paid.

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Setting It Up

Designing the scheme properly

• Decide who is covered, and write down why. A board resolution or partners’ decision recording the employees covered, the premium budget and the purpose keeps the expense defensible.
• Choose protection before savings. For most employees, a pure term policy gives far more cover for the same budget. If the goal is a long-term reward, compare a savings plan’s returns honestly against simply paying a higher salary or bonus.
• Check the premium limits. For savings-type policies, test the 10% ratio and the ₹5 lakh aggregate limit against the employee’s other policies before choosing the premium.
• Put any conditions in writing at the start. If the benefit depends on the employee staying for a period, record that in the employment terms, not as an informal understanding.
• Report the perquisite correctly. Under Route A, the premium must be included in the employee’s salary and taxed through payroll.

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Avoid These

Common employer-employee scheme mistakes

1. Assuming the payout is tax-free because “it is life insurance”

Life insurance proceeds are exempt only when the policy qualifies. Employer-owned policies, and savings policies above the premium limits, do not.

2. Using it as a tax shelter

Structures built mainly to turn large deductible premiums into a later lump sum for a director attract scrutiny from the tax department and are already the subject of litigation. A scheme should be judged as an employee benefit, on its cost and value.

3. Confusing it with keyman cover

Keyman insurance protects the business against losing a person. An employer-employee scheme rewards and protects the employee. They solve different problems, and a business may need both.

4. Forgetting the employee’s own planning

A policy that ends when the employee leaves is not a substitute for their own term insurance. Encourage covered employees to keep personal cover that does not depend on their job.

Questions

Frequently asked questions

Is the premium paid by the employer taxable for the employee?

Yes, when the employee owns the policy. A sum paid by the employer to effect an assurance on the employee’s life is a perquisite under section 17(1)(g) of the Income-tax Act, 2025 (section 17(2)(v) of the earlier Act), and is added to the employee’s salary.

Can the employer claim the premium as an expense?

Generally yes. When the premium is part of the employee’s remuneration, it is deductible as business expenditure under the general deduction, now section 34 of the 2025 Act.

Is the maturity amount tax-free for the employee?

Only if the employee owns the policy and it meets the Schedule II conditions: premium within 10% of the sum assured and, for non-ULIP policies issued on or after 1 April 2023, total premium within ₹5 lakh a year. Employer-owned policies are keyman policies and are not exempt.

What is the difference between keyman insurance and an employer-employee scheme?

Keyman insurance is owned by the business and pays the business, to protect it against losing a key person. An employer-employee scheme is a benefit for the employee and their family. If the business owns the policy, though, the tax law treats it as keyman insurance either way.

Is group term insurance better than an employer-employee scheme?

For covering many employees at low cost, usually yes. Group term life covers everyone under one contract. Individual employer-employee policies suit a small number of senior people where a tailored benefit is the goal.