Tax treatment of life insurance

When putting together a life insurance plan it is important to understand and consider the tax implications of what you are doing.

Each type of insurance is treated slightly differently when it comes to taxation, and that includes the tax treatment of both the premiums and the claim proceeds.

In this guide we will look at the tax consequences for each different type of life insurance.

Term Life Insurance

Term life insurance will pay you a lump sum when you die or are diagnosed with a terminal illness that leaves you with less than twelve months to live.

The premiums for term life insurance are not tax deductable, and the proceeds from the insurance are generally received tax-free.

The tax-free status of a term life insurance payout can be affected when paid via a superannuation fund and/or when paid to a non-financially dependant person. If you plan on leaving your life insurance to a non-financial dependant such as a family friend you should first seek professional tax advice.

TPD Insurance

TPD stands for total and permanent disability. TPD insurance will payout if you suffer an injury or illness that leaves you totally and permanently disabled and unlikely to ever return to work.

The premiums for TPD insurance are not tax deductable, and as with term life insurance the proceeds from any claim will be received free of tax.

Trauma Insurance

Trauma insurance will payout in the event of suffering a critical illness, condition or event such as a heart attack, stroke or cancer.

Trauma insurance premiums are not tax deductible, and the proceeds from a trauma insurance claim are not taxable.

Income Protection Insurance

Income protection differs from the other types of life insurance in that it pays you an ongoing income rather than a lump sum. The insurance covers you whilst you are unable to work due to injury or illness.

Premiums for income protection insurance are 100% tax deductible, however the claim payments you receive from the policy will be taxed at your marginal tax rate. For this reason it is important to consider the tax implications when calculating your income protection amount, as any benefit will be reduced by the tax payable.

Investment Income

Often the proceeds of a term life, TPD or trauma insurance policy will find their way into a savings account or other investment type. Whilst these funds will have been received tax-free, you need to be aware that any interest earned on the funds will be subject to tax.

For example a person may calculate that their family requires $60,000 income to survive on. Based on an assumed interest rate of 6% the person may decide to take out a life insurance policy of $1,000,000 believing that in the event of their death this can be placed into a savings account that will provide enough income for the family to survive on.

What this doesn’t take into account is that the $60,000 per year interest income will be subject to tax, meaning that the family may not be left with enough income to survive on.

Professional Advice

Taxation is a very specialised area, and when making decisions on life insurance that will be affected by tax it is strongly recommended that you seek advice from a qualified tax professional.

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