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Life Insurance

Life Insurance and Taxes – What Your Family Needs to Know About Claiming On Your Policy

24 Aug 2020

Life Insurance by Life Stage

The choices you make today can impact your long-term health, wealth and happiness. Understand the important role Life Insurance can play in key life events.

Are you thinking about buying life insurance?

If so, it may be wise to weigh your options with care. And then you still have to ensure your family knows what to expect.

It’s not like people actually look forward to filing a claim on a life insurance policy. That’s understandable, as this would usually mean the death of a loved one.

However, it’d be worse if you were to pass away and leave your loved ones to fend for themselves all on their own.

And that’s probably why you’re considering taking out a life insurance policy.

On the part of your family, lodging a claim on a life insurance policy can be quite involved. It’s not as easy as filling out and sending off a claim form. Your beneficiaries may also have tax liabilities to consider.

Whether they will owe any money to the Australian Taxation Office (ATO) depends on a number of factors. In a lot of cases, however, life insurance settlements are not taxable – particularly when the payment is made to a financial dependent. But that’s not always the case.

If it’s purchased through your superfund, your family most likely would be eligible for a tax-free payout. However, if the payment goes to an adult who is not classed as a financial dependant, then even if the adult is a family member the payment is usually subject to tax.

But that’s not all. Here are some other important things to know about life insurance, particularly in relation to taxes. Keep in mind that these are general observations – people’s financial circumstances are different and we suggest you obtain professional advice (such as from an accountant) when making decisions with taxation implications.

First… In Limited Cases You May Be Able to Deduct Premiums

You might first look into whether the premiums for your life insurance are tax-deductible. As it stands, you can’t deduct the premiums. There are some limited circumstances when it may be deducted, when purchased through a self-managed super fund. You could get tax advice on this.

There are three types of life insurance products in Australia in addition to  Life cover (which is sometimes known as term life cover). They are Trauma insurance, Total and Permanent Disablement (TPD) insurance, and Income Protection insurance. And the ATO has different rules for all of them.

For example, you generally can’t deduct the premiums of your trauma insurance. That’s also the case for the premiums for a TPD policy.

In contrast, typically you can deduct the premiums of a standalone income insurance policy (standalone, as in purchased independently of your superannuation). If purchased through your super, your income insurance premiums are only tax-deductible if you’re self-employed.

The rules are complex and change from time to time. Most Australians will want to consult a tax or financial consultant.

Is the Payout Subject to Tax?

A life insurance policy isn’t going to replace you or your status as the breadwinner. The point of getting one is to help your family pay off debts and also cover their living expenses before they can get back on their feet. Every dollar counts and it’s even better if the payout is tax-free.

And it just so happens that term life cover insurance payouts in Australia are tax-free in most cases. That means the beneficiary or beneficiaries are free to spend the money in any way they see fit.

However, as noted before, the payment may be taxable if made to an adult who is not a financial dependant. Additionally, two other potential exceptions worth noting have to do with:

  • Payouts for life insurance policies held in super funds
  • Payouts for the life insurance policies of company key persons

But still, this is not automatic, as you’re going to find out below.

Life Insurance Held in Superannuation

As mentioned earlier, the premiums can possibly be tax-deductible. This is why some Australians choose to hold their life insurance in their self-managed super fund.

However, the tax liability is more complicated. It depends on the beneficiary’s relationship with the policyholder. More specifically, the beneficiary must be a dependent to be exempt. Furthermore, the superannuation act defines a number of eligible types of dependent relationship.

Typically, a spouse and underage children (under 18) will not be subject to tax.

In addition to the obvious, a former spouse may also be exempt. The other two types are another financial dependent (not previously defined) and a beneficiary with whom the deceased had an interdependent relationship.

As you may have noticed, the definition of dependents may be different under the superannuation law and the tax law. And this may cause confusions and complications. It’s best to consult your financial advisor if you’re unsure.

Weigh Your Options Carefully

Having a life insurance policy helps ensure that you can still care for your loved ones after your passing. The payout can help them take care of financial obligations and gain a footing.

The good news is that the payout will be tax-free most of the time. But there are also important caveats.

If held in your super, the beneficiary must be your dependent to get a tax-free payout.

Now, if you’re wondering if your family would have to pay tax, you’re probably considering this question:

To insure or not to insure?

That is a question that only you can answer. You may choose to get some professional advice, or to carefully consider your own needs and circumstances and deal directly with a Life Insurer like NobleOak who can provide you with general advice and product information. We suggest obtaining professional advice in connection with how tax applies to your situation.

This is general information only and does not take into consideration your individual circumstances, objectives, financial situation, or needs.

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