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:
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.
Life insurance inside vs outside superannuation
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).
More questions about death and taxes