Tax On Life Insurance

Understanding taxes on life insurance premiums and payouts

Generally, a life insurance payout to your dependants won’t be taxed and can be paid as either a lump sum or income stream. However, the tax-free status of death benefits can be affected when purchased via a superannuation fund and/or is paid out to non-dependants.

Use this guide to help you navigate through the confusion of life insurance and taxes:

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Are life insurance premiums tax deductible?

Life insurance premiums are tax-deductible if you’re self-employed and your policy is owned by and purchased through a superannuation fund. However, if your life insurance policy is privately owned, then your premium payments are generally not tax deductible.

The premiums for a policy that is owned by a superannuation fund are tax-deductible to the fund because Super-owned policies are typically paid with pre-tax dollars.

There is a 15% contributions tax applied on super contributions, including insurance premiums. However, these are typically refunded in the form of a rebate to members (the life insured) as the fund can claim it as a tax deduction.

Under a keyman structure, premiums are often tax deductible, but benefits are taxable. This is due to the policy being owned by a company or business partner.

Is life insurance payout taxable in Australia?

Whether your life insurance payout is taxable in Australia generally depends on how your policy is owned and who your beneficiaries are. For instance, a life insurance benefit paid directly to your spouse or financial dependant is not subject to taxation.

  1. Inside Super: You bought your life insurance through a superannuation fund, so the payout can be taxed if paid to non-financial dependants with a tax rate of up to 35%. However, your payout won’t be taxed if your death benefits are paid to a financially dependant beneficiary, for example, your spouse or children.
  2. Outside Super: Tax on a benefit is subject to the beneficiaries and is not determined by super or non-super ownership. So, the lump sum benefit could be taxed in either circumstance but is almost always taxed when owned by a business or business partner, or when paid to a non-financial dependant or adult child.

Life insurance inside vs outside superannuation

Tax for life coverOutside SuperInside Super
Premiums
  • Premiums are not tax deductible.
  • Premiums are usually deductible when premiums are paid from your pre-taxed income. Your super fund can claim the refund on your premiums and then pass it on to you.
Payouts
  • Payouts are usually not taxed when paid to your dependants.
  • Payouts can be taxed up to 35% if paid to non-financial dependants.
  • Payouts are usually not taxed when paid to your dependants.
  • Payouts can be taxed up to 35% if paid to non-financial dependants.

Just because premiums are tax deductible under a Super fund, does not mean it’s the best option for you, especially considering your beneficiary might have to pay taxes on your death benefit.

When choosing how you’ll purchase your life insurance, you should carefully consider your personal circumstances and needs.

How does life insurance payout?

Generally, your life insurance policy will pay a lump sum to your nominated beneficiary. You can also choose to have your insurer pay the money to your beneficiary at a later date or in a series of instalments. If you do not nominate a beneficiary, your death benefit will be paid to your estate and divided according to your Will and Testament.

Average life insurance policy payout

Your life cover payout amount depends on the policy you purchase and the amount of cover you took out. That’s why it’s crucial to read your policy disclosure statement (PDS) and policy schedule to make sure you know precisely what will happen in the event of your death or diagnosis of a terminal illness. That said, the majority of life insurance payouts range from $100,000 to $2,000,000.

However, most insurers don’t have a minimum benefit limit, plus maximum benefit amounts are only restricted by a client’s justifiable need.

Will my beneficiaries have to pay tax on my life insurance payout?

Usually, your death benefit will be paid to your spouse and/or dependants as a tax-free lump sum. However, there are a few instances in which your beneficiaries might have to pay tax on the life insurance payout.

Your beneficiaries might have to pay taxes if:

  • Your beneficiaries are not financially tax dependants as defined in the Income Tax Assessment Act 1997, this typically refers to a child over the age of 18 who is no longer financially dependent on you at the time of your passing.
  • The executor of your will holds onto the death benefits after your death, any interest earned during the holding period could also be taxable as part of your beneficiaries’ income.
  • The ownership of your life insurance policy is held by a third party or business before your death for monetary value or other consideration.

Life insurance and taxes are complicated, which is why it’s best to consult with a qualified professional when planning how you’ll support your family after death.

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SIS dependant vs tax dependant

SIS dependant: A superannuation death benefit can only be paid to a person or entity that is dependent under the Superannuation Industry (Supervision) Act 1993 (SIS Act 1993).

Tax dependant: Dependant under the Income Tax Assessment Act 1997 (ITAA 97), which will determine the tax paid, but not the eligibility of the person to receive the benefit.

In other words, although a child of any age is a SIS dependant, only a child under 18 is a tax dependant. Also, while a former spouse is considered a tax dependant, only a current spouse is a SIS dependant.

Where an individual has no dependants under the SIS Act, their superannuation will be passed as a lump sum to their legal representative, usually the executor of their Will (assuming they have one).

How is life insurance paid out to beneficiaries?

Your life insurance policy is paid out to your appointed beneficiaries in the form of a lump sum, or in a series of instalments. Who you choose to nominate as a beneficiary to receive this payout is an important consideration, because it can mean the difference between the money going to your family or paying outstanding debts.

If there are no nominated beneficiaries the payout is directed to your Will and will become part of your ‘residual Estate’ and paid to your residual beneficiaries at the discretion of the Executor of your Will.

More questions about death and taxes

How do I get tax-free life insurance?

When your life insurance is paid out to your dependants, for example, your spouse or child, the benefit will usually be tax-free. However, the payout will generally be taxed if your cover is through a super fund and pays out to a non-dependant, like your business partner or adult child.

When to consider a life insurance policy to cover inheritance tax

In Australia, the once-off fee called ‘inheritance tax’ has been abolished and replaced by a variety of taxes that your beneficiaries may be responsible for. The Capital Gains Tax, for example, is what your beneficiary will pay on the capital gain on the sale of assets.

Whether they pay any taxes, however, depends on the type of gift received under your Will and the way in which the gift was given. For example, if you give your spouse a property in the Will, then when and how much the property is sold for will determine if your spouse will pay any taxes.

More and more Australians are turning to life insurance to provide their loved ones with financial security should they pass away. Take control of what will happen to your family’s financial future by comparing policies and choosing the right one for your specific requirement.

Published: November 2, 2017
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