Do I Have to Pay Tax on Life Insurance Pay-Outs?
Worried that you or your beneficiaries have a significant tax liability from your life insurance payout? Planning effectively will eliminate this concern. Life insurance is meant to provide peace of mind, not tax burden. This article will help you understand the implications of tax on life insurance payout in Australia.
What Life Insurance Products Are Available in Australia
In Australia, there are four (4) major types of life insurance policies that provide coverage for life uncertainties.
Life Insurance (In Case of death)
Life insurance or death insurance coverage pays a lump sum benefit when the insured prematurely dies or is diagnosed with terminal illness.
Income Protection Insurance
Income protection insurance provides up to 70% of pre-disability monthly income when the insured is unable to work due to sickness or injury.
Total Permanent Disability (TPD) Insurance
TPD insurance pays lump sum benefits in case of total and permanent disability of the insured due to illness or injury. The definition of disability can vary depending on the insurer.
Critical Illness Insurance
Critical illness insurance or trauma insurance provides the insured with a lump sum benefit when diagnosed with severe medical conditions such as cancer, stroke, or heart attack.
Are Life Insurance Pay-Outs Taxed?
Generally, in Australia, life insurance payouts are usually tax-free, however, some instances may indicate your payouts as taxable. This article will help you determine whether you owe the taxman or not.
As a general rule, personally owned life insurance policies will have tax-free payouts where it is held outside of superannuation. This allows the insured or the beneficiaries to access the full coverage amount and use it for financial support.
However, these situations may require you to pay tax on life insurance payout:
- When your life insurance policy is held within Superannuation
- The life insurance is held for business insurance purposes (key person primarily) or when your insurance is owned by a third party.
What Types of Life Insurance Are Tax-Deductible?
In Australia, payouts from these types of life insurance policies that are made to your dependents are typically tax-free when they are not owned through superannuation:
- Life insurance (in case of death)
- Trauma or Critical Illness insurance
- Total and Permanent Disability (TPD) Insurance
Generally speaking, people who are considered by the Australian Taxation Office to be dependent on a policyholder include:
- The policyholder’s spouse (this can include a de facto spouse of the same or opposite sex)
- A former spouse
- Children under the age of 18
- Another type of financial dependant or;
- Someone with whom the policyholder had an interdependent relationship with
It is important to note that there are differences between what is required to be considered a dependent under superannuation legislation (SIS Act) and under taxation law. These differences can result in significant complications should you require a payout. It is important to seek advice from a financial adviser when weighing up your options.
Life insurance policies within superannuation funds can lie dormant for decades. The benefits of these policies are significantly reduced when the policyholder’s children turn 18 and are no longer considered financially dependent by the ATO.
While for income protection insurance, benefit payments are unlikely to be tax-free due to the nature of the coverage.
Tax Considerations for Life Insurance Policies Held Within Super Funds
Having your life insurance policy owned and funded through a superannuation fund may result in a tax liability in the event of a payout.
The ability to effectively claim a tax deduction on your premiums is a common reason why Australians take out life insurance policies inside their super funds. This is achieved by making additional concessional contributions to your fund, in the amount of your insurance premiums, and claiming a deduction on said contributions. However, when claiming payout benefits, the implication of taxes can be complicated.
This is because life insurance benefits will form part of the superannuation fund’s “death benefit”. The lump sum amount paid to the dependant is tax-free, while for non-dependants, the proportioning rule will apply to calculate taxes.
Are Life Insurance Premiums Tax-deductible?
While having life insurance, trauma insurance, and TPD insurance outside of your super allows you to have tax-free payouts, the premiums you pay, however, are typically not tax-deductible where your policy is personally owned.
But for income protection insurance, the premiums are generally tax-deductible.
For easier comparison, you may refer to this guide:
Please note that the payouts refer to policies held individually, for personal purposes only.
| Insurance Type | Tax-Deductible Premiums | Tax-Free Payouts |
|---|---|---|
| Life insurance (outside super) | No | No (when paid to a non-dependant) |
| Life insurance (inside super) | No | Yes |
| Income Protection Insurance (outside super) | Yes | No |
| Income Protection Insurance (inside super) | No | No |
| TPD Insurance (outside super) | No | Yes |
| TPD Insurance (inside super) | No | No |
| Trauma Insurance (outside super) | No | Yes |
Do Owners of Key Person Insurance Policies Have to Pay Tax on a Pay-Out?
What makes key person insurance unique is it offers financial stability to a business, not a family.
This is a type of insurance that businesses take out to protect themselves from the loss of a person who is vital to the success of their business. They can be a partner, a director, or a staff member with skills that are crucial to the business’ operations.
However, the benefits of key person life insurance policies are rarely tax-free.
Paying Income Tax on Key Person Insurance:
Businesses often take out key person insurance to protect their revenue (by covering losses, training replacements, or paying debts, for example). When this insurance is purchased to mitigate revenue losses, any life insurance benefits paid will be seen as income and the benefits of the policy will be taxed accordingly.
Paying Capital Gains Tax (CGT) on Key Person Insurance:
Using key person insurance for capital purposes such as paying debt, the benefit amount will not be subjected to income tax – but the business may still have to pay the capital gains tax.
This is because the ATO views the payment of the life insurance policy as the disposal of a CGT asset.
But, before you worry about whether payment of your key person insurance benefits might be considered a capital gain, take a moment to familiarise yourself with the two major exemptions the government has put in place.
Under section 118-300 of the Income Tax Assessment Act 1997, the law states that CGT is not payable on a life insurance benefit when:
- The life insurance benefits are distributed to the “original beneficial owner” of the policy (note that this could mean two or more people who have joint ownership of a policy or it could also be a business or a trust) or;
- The person receiving the benefits of the policy “gave no consideration” in exchange for the life insurance cover.
In this context, an “original beneficial owner” is the person who first possesses or controls the policy.
And, “consideration” is a legal term that, when talking about CGT exemptions for life insurance policies, basically means doing or giving something in exchange for something else. This could be paying money, giving gifts, offering rights, or making another sort of exchange.
Find Out More About Life Insurance Taxation
Understanding the impact of taxation on your life insurance payouts will help you maximise the benefit that you or your beneficiaries will receive during challenging times.
Life insurance is your promise to your loved ones or a promise to you by a family member who passed away, let us help you fulfill it. At Curo Financial, we are experts in life insurance claims and we have helped hundreds of Australians over our decades in the industry. We provide expert advice and assistance so that our clients can make an informed decision on their finances. Talk to us.
Dial 1300 665 356, email [email protected] or enter your contact details into our online form, and we’ll ensure that your insurance needs are met!
FAQs
Is life insurance payout taxable in Australia?
In Australia, a life insurance payout is usually tax-free. However, in cases where your life insurance policy is held within your superannuation or your life insurance is used as key person insurance, you may have to pay taxes.
What is the tax rate for life insurance payout in Australia?
For life insurance policies held outside of superannuation, the lump sum benefit amount is tax-free. But for life insurance policies within the superannuation and for key person insurance, you may have to pay taxes on the payouts.
Are life insurance payouts in superannuation taxable?
Life insurance payouts may taxed if the policy is held within superannuation.
General Advice Disclaimer
General advice warning: The advice provided is general advice only and in preparing it we did not take into account your investment objectives, financial situation or particular needs. Before making an investment decision on the basis of this advice, you should consider how appropriate the advice is to your particular investment needs, and objectives. You should also consider the relevant Product Disclosure Statement before making any decision relating to a financial product.
