Insurance Premiums and Tax
The tax treatment of life insurance premiums can be complicated. That said, if you can make your insurances as tax effective as possible, you can save many thousands of dollars over the life of your policies.
In recent weeks, we have been analysing the 2019 Federal Budget. As we wrote earlier, the way in which the Government collects and spends money is often aimed at a particular social impact. When the Commonwealth offers a tax deduction, it is typically one way of encouraging people to spend accordingly. So, in this article, we look at life insurance premiums and whether and/or how they can be deductible.
Death Cover
For an individual, premiums for death cover are not deductible. So, if you take out a policy directly, you will need to pay the premium using after-tax dollars.
However, a superannuation fund is allowed to provide death cover to its members. And premiums for death cover are deductible to a superannuation fund. What’s more, contributions made either by you or on your behalf into a superannuation fund are typically paid out of pre-tax dollars (either by your employer or by yourself). So, if you can access the same or a similar type of death cover through superannuation, the premium can be effectively tax-deductible. Let us explain with an example.
Let’s say you wish to take out $1 million of death cover. The premium is $2000 per year. Your income is $100,000 per year, meaning that your effective tax rate (including the Medicare levy) is 39%.If you take the policy out in your own name, you need to finance the $2000 using after-tax income. This means you actually have to earn $3270 in order to pay the premium. You pay tax of 39%, or $1,270, leaving $2000 available for your premium.
If you access the policy through a superannuation fund, the fund needs to finance the $2000. But the premium is deductible to the fund, so it can use $2000 of pre-tax income. This means that you can make a contribution of $2000 into the fund to pay the premium. If the $2000 contribution is a personal concessional contribution, then you can use your pre-tax income to pay it. This means you only have to earn $2000 in order to pay $2000 into super. The fund then uses this money to pay the premium.
It takes much less time to earn $2000 pretax than it does to earn $3270 pretax. So, the death cover is cheaper when taken out through super.
There can be a ‘catch.’ If the insured event occurs (which means you die), then the superannuation fund will receive the benefit from the insurer. There are rules regarding how your super fund can pay benefits to other people if a member dies. If the benefits are paid to what is known as an ‘eligible death benefit recipient’ (a spouse, a child or another person who is financially dependent on you), then the benefits are not taxed as they come out of the fund. If the benefits are paid to someone who is not an eligible death benefit recipient (for example, a financially independent adult child), the benefits can be taxed. This can mean that you have effectively insured for a lesser amount.
That said, the vast majority of people who take out death cover do so because they want to provide for people who qualify as eligible death benefit recipients. The most typical examples are partners and children. For that reason, the potential tax impact on a death benefit paid through super does not usually mean that super is the wrong method through which to purchase death cover. In fact, most people should consider taking death cover through a superannuation arrangement.
Income protection
In general, premiums for income protection insurance are deductible. This means that it can often be cheaper to take out income protection in your own hands than through some other mechanism such as a super fund.
The quid pro quo is that income protection benefits are generally taxable as income if and when a claim is made.
Total and permanent disability (TPD)
Total and personal disability premiums are a little bit complicated when it comes to tax. Basically, there are two types of TPD: any occupation and own occupation. If you take out either type of TPD in your own name, the premium is not tax-deductible.
However, any occupation TPD can be taken out through super. This means that the premium for this kind of cover can be tax effective in the same way that death cover premiums can be tax effective (see above).
Unfortunately, own occupation TPD cannot be taken out through super. This is a pity, because own occupation is more comprehensive cover than any occupation.
In simple terms, an own occupation policy basically comprises an any occupation policy plus some extra cover. For this reason, some insurers divide an own occupation policy into the any occupation component and the extra cover component. They then offer the any occupation component through a super fund, allowing the portion of the premium used for this component to be made tax effective. The extra cover is held outside of super.
As we say, this situation can be quite complicated. This is why especially recommend that you never ‘do it yourself’ when it comes to TPD cover.
Trauma cover
Premiums for trauma cover are not tax-deductible. What’s more, new trauma policies cannot be held within super. Basically, if you wish to take out trauma cover, you need to hold the policy in your own name and pay the premium using after-tax dollars.
