What You Need to Know About Life Insurance Tax Deductions

Having life insurance can mean the difference between your loved ones being looked after or struggling to make ends meet, or your business continuing to flourish, should the unexpected happen.

But when it comes to life insurance cover, claims and premiums, it pays to know how the Australian Tax Office (ATO) treats tax deductions against it, to help you find the best strategy to optimise and offset it.

The complexities of tax deductions and claims on life insurance

When it comes to life insurance, there’s a fair amount of complexity in tax deductions on premiums and how claims are treated by the ATO. The type of cover adds to this complexity, and there are both opportunities as well as traps hidden within them, especially for those in higher wealth brackets.

As a professional, you may be looking for the right tax strategy on how to structure your life insurance so you can get the best balance between:

• Cash flow
• Tax treatment
• Insurance cover and protection

To ensure you best optimise this balance, let’s look at the issues and considerations from a high-level point of view.

Tax considerations for life insurance policies

Insurance premium deductibility outside of superannuation

Outside of superannuation, premiums on the following insurance types are not tax-deductible:

• Death
• Total and permanent disability (TPD)
• Trauma

While the following premiums are:

• Income protection
• Business expense protection

Insurance claim payment tax treatment outside of superannuation

Claim payments against policies covering death, TPD and trauma are 100% tax deduction free, regardless of whom they are paid to.

However, income protection and business expense protection claims are classed by the ATO as income, so need to be declared. This makes sense when you consider that business expense payments naturally offset the actual expenses they’re intended to cover.

Tax treatment of business purpose policies

When it comes to life insurance policies held for business purposes, there are some tax concessions. This includes buy/sell agreements and policies that cover revenue lost in the event of the death or disablement of a key person within the business.

With these types of policies, they’re typically held by the business. The premiums are tax-deductible for the business, but payments of claims against the policies are regarded by the ATO, depending on the purpose of the tax cover, as income or a capital gain.

Bear in mind that Fringe Benefit Tax (FBT) can also apply where the business is paying ownership protection premiums on behalf of its individual owners.

Tax on life insurance claims paid through superannuation

Generally speaking, the death benefits of a life insurance policy paid through superannuation are tax-free, provided they’re paid to a dependent – and this term is very strictly defined under the law.

If the benefits are paid to people defined as non-dependents, they’ll likely be subject to tax on part of the balance, with some tax-free component. The applicable tax rate is likely to be either 15% or 30%, depending on the circumstances.

When it comes to a lump sum benefit under total and permanent disability insurance policy, a portion of this is also likely to be tax-free, while the remainder will be subject to a variable tax rate; what tax rate is applied will be assessed against the policyholder’s age and eligible service period.

Optimising and offsetting tax on life insurance policies

There are a number of tax strategies to optimise and offset tax on life insurance policies, including:

• Taking insurance policy claim benefits as an income stream to qualify for tax offsets
• Maximising the uplift in the tax-free portion of the benefit to increase it
• Washing out taxable components

When working out and planning the best tax strategy to achieve a balance between cashflow, tax and insurance cover, seeking advice from a professional, trusted tax adviser is recommended, so that you ensure you, your family or your business have the optimal cover, should the worst-case scenario happen.

Get tax advice from the professionals

Here at Clarity Taxation, we’re the tax experts that you can trust. If you’re looking for the best tax strategies to balance life insurance cover with tax deductions, we’ll work with you to ensure you achieve this, while remaining compliant with the ATO. Contact us today for tax accounting services you can rely on.