Life Insurance Taxation In Australia: What You Need To Know

Life insurance is a crucial safety net for families and loved ones, but the tax implications can be confusing. In Australia, the tax status of life insurance depends on the type of policy, where it was purchased, and who receives the payout. While some insurance premiums are tax-deductible, most are not. This includes direct life insurance premiums, which are generally not tax-deductible, although there are some exceptions, such as when the policy is held within a superannuation fund or for business purposes. On the other hand, life insurance payouts are often tax-free, especially when paid to a financial dependent, but there are some instances where tax may be applicable. Understanding the tax implications of life insurance is essential for policyholders, and seeking advice from a qualified tax professional or financial advisor is recommended.

Stamp duty on life insurance premiums

Stamp duty is a government fee that may be charged in addition to your life insurance premium in Australia. The amount of stamp duty you pay depends on the state in which you reside. For example, in South Australia, you'll pay 1.5% of the first year's premium on the policy, while in New South Wales, Victoria, Queensland, Tasmania, the Northern Territory, and the Australian Capital Territory, you'll pay 5%. There is no stamp duty on life insurance in Western Australia, and, as of 1 July 2014, it was abolished in Victoria.

The liability for stamp duty on insurance rests with the insurer, but they are allowed to pass this cost on to the policyholder. Stamp duty is calculated on the GST-inclusive value of a premium.

Insurers must lodge a monthly return, showing all premiums collected in the preceding month, and pay on or before the 21st day of each month. If your insurer is not registered, you are responsible for paying the duty and must lodge a return and pay within 21 days after the end of the month in which you paid the premium.

Tax on life insurance payouts

Life insurance payouts can be taxable or non-taxable, depending on the type of cover, where the policy was held, and who receives the payout.

Payouts from policies held outside of superannuation are generally not taxable. This means that beneficiaries won't have to declare them or pay tax on the payout. This applies to life insurance, total and permanent disability (TPD) insurance, and trauma cover. However, payouts from income protection insurance are usually taxed on a monthly basis.

For policies held within superannuation, whether or not a life insurance or TPD insurance payout is taxable depends on the relationship with the beneficiary and how it's paid, among other things. If the death benefit is paid out as a lump sum to a spouse, child, or someone in an interdependent relationship with the deceased, the payout is typically tax-free. If the death benefit is paid out to a non-tax-dependent, such as adult children, the payout may be subject to tax.

The tax obligations on life insurance payouts can be complex and vary depending on individual circumstances and changing tax laws. It is recommended to seek advice from a qualified tax professional or financial advisor to understand the specific tax implications of your situation.

Types of Life Insurance and Tax Implications

There are four main types of life insurance:

• Life Insurance: Also known as term life insurance, this type of insurance provides a lump sum payment to beneficiaries in the event of the policyholder's death or terminal illness. It is typically tax-free for beneficiaries.
• Total and Permanent Disability (TPD) Insurance: TPD insurance provides a lump sum payment if the policyholder suffers an illness or injury that prevents them from working. This is usually tax-free for beneficiaries but may be taxed in some cases.
• Critical Illness Insurance: This type of insurance pays out a lump sum if the policyholder suffers a serious medical event, such as a heart attack, stroke, or paralysis. It is often used to cover medical treatment and rehabilitation costs and is typically tax-free for beneficiaries.
• Income Protection Insurance: This insurance provides a benefit, usually in monthly instalments, if the policyholder is unable to work due to sickness or injury. This type of insurance is unlikely to be tax-free and is often taxed as regular income.

Tax on income protection insurance

Income protection insurance is designed to replace your income if you are unable to work due to partial or total disability caused by illness or injury. It can be especially useful for those who are self-employed, small business owners, or those with family members or dependents who rely on their income.

In Australia, the premiums you pay for income protection insurance are tax-deductible if the policy is purchased outside of your superannuation fund. This is because the premiums you are paying relate to your income. However, if you have income protection insurance through your superannuation fund, the premiums are not tax-deductible as they are deducted from your contributions.

If you receive a payment under an income protection policy, this must be included in your tax return and is treated as income. This applies to both regular payments and lump-sum payments. However, if you receive a payment for personal injury or total and permanent disability under the policy, the payment may be treated as a capital gain.

The Australian Taxation Office (ATO) states that insurance premiums are not tax-deductible if the policy pays a benefit for physical injury. Therefore, income protection insurance is an exception to this rule, as it is designed to replace your income if you are unable to work for a set period of time.

Life insurance through superannuation

However, there are also some disadvantages to consider. Here are the key points to be aware of regarding life insurance through superannuation:

Premiums and Cost

While it is often assumed that super fund insurance will be cheaper than a retail policy, this is not always the case. Group rates may not always translate into cheaper rates for all members, and rising claims have led to significant increases in premiums for some super funds. Additionally, the cost of death cover inside super tends to increase with age, making it more expensive for older members.

Renewable Policies

Industry or employer super fund policies are not guaranteed renewable, as the terms and conditions can change when the contracts are renegotiated. In contrast, retail insurance policies have guaranteed renewable terms.

Adequacy of Cover

The default Life and TPD cover provided by super funds is often inadequate for most people's needs. While 94% of working Australians have some form of life insurance through their super, the median level of cover is typically much lower than the recommended amount. It is important to assess whether the default cover meets your specific needs.

Choice of Beneficiaries

Superannuation insurance has more restrictions on who can be nominated as a beneficiary compared to retail policies. Super beneficiaries are limited to financial dependants or your estate, whereas retail policies allow for a wider range of beneficiaries.

Speed of Claims Payment

Claims payment through super funds can take longer than with retail policies. The insurer pays the benefit to the trustees of the super fund, who then need to determine if a condition of release has been met and who should receive the proceeds.

Tax Implications

While Life and TPD benefits are generally tax-free when owned personally, they may be subject to tax if held within a super fund and paid to a non-financial dependent. Additionally, for TPD insurance, a portion of the lump sum payment may be taxable unless you are over 60.

Impact on Retirement Balances

The premiums for superannuation insurance are paid from your super balance, reducing your retirement savings over time. This can have a significant detrimental effect on the retirement balances of those with low incomes or intermittent work.

Expiry Ages

Super death policies typically have lower expiry ages than retail policies, usually set at 65 or 70. While the need for life insurance after retirement may be limited, the cost of alternative cover can be relatively high.

Available Benefits

Retail insurance policies often offer a wider range of benefits than super policies due to legislative restrictions on superannuation insurance. Retail policies may offer additional benefits such as funeral cost coverage, reimbursement of financial planning costs, grief counselling, child trauma cover, and accommodation cost coverage for terminal illness.

Exclusions and Coverage Limitations

Super fund default cover may have general exclusions for pre-existing health conditions, and these exclusions may not always be clear to the policyholder. In contrast, retail policies are fully underwritten upfront, providing certainty about what is covered.

Premium Types

Most super funds offer stepped premiums that increase with age, while retail policies may also offer level premiums that remain constant over a longer period. Level premiums can provide significant savings for those holding policies over the long term.

Continuation of Cover

Industry super funds may have rules that cause insurance cover to cease if you stop contributing or if your super balance falls below a certain level. Retail policies, on the other hand, typically continue as long as premiums are paid.

Portability

Superannuation insurance policies may not be portable if you change super funds, and transferring your policy to personal ownership may require health checks and higher costs. Retail policies are not affected by changes in employment or super funds and can be paid for using a super balance with a rollover discount.

TPD Cover Definition

Super funds are restricted to offering TPD (Any Occupation) cover, which requires the policyholder to be unable to work in any occupation suited to their training, experience, or education. Retail policies can offer TPD (Own Occupation) cover, which is more suitable for skilled or specialised occupations.

Income Protection Coverage

Income protection through super may stop when you are unemployed, whereas retail policies generally continue to cover you during periods of unemployment. Additionally, super fund income protection policies typically have shorter benefit periods and more restrictive indemnity definitions compared to retail policies.

Tax Deductions for Income Protection Premiums

Income protection premiums paid for a retail policy can be claimed as a personal tax deduction, but this is not the case for policies provided by super funds. This means there is no tax advantage to having income protection through super.

Life insurance outside of superannuation

According to the Australian Taxation Office (ATO), insurance premiums are not tax-deductible if the policy pays a benefit for physical injury. Therefore, only income protection insurance is tax-deductible outside of superannuation.

While life insurance outside of superannuation is usually not tax-deductible, the payouts from these policies are generally not taxable. This means that you or your beneficiaries will not have to declare them or pay tax on the payout. This applies to life insurance, TPD insurance, and trauma cover held outside of superannuation.

However, if you receive a payment under an income protection policy, you will likely need to include it in your tax return, regardless of whether it is a regular payment or a lump sum. This is because any payments received from income protection insurance are generally considered taxable income.

It is important to note that the tax implications of life insurance can be complex and may vary depending on individual circumstances and changing tax laws. It is always a good idea to seek advice from a qualified tax professional or financial advisor to understand your specific tax obligations.

Frequently asked questions