Navigating the tax implications of any life insurance policy can be overwhelming. This article aims to help individuals intending to purchase personal or family life insurance be better equipped to make informed decisions and assess the potential impact of taxation on their policy. We’ll give you an overview of the tax laws relating to life insurance, including whether payouts and premiums are taxable, and how GST applies. This article is of a general nature and is not to be taken as tax advice. If you are making a financial decision from this information, please consult with your accountant or tax specialist before doing so.
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Tax-free insurance benefits
Life insurance policies provide financial security to beneficiaries if the policyholder passes away unexpectedly. When a policy pays out, it is referred to as a ‘life insurance payout’ or ‘death benefit’.
In New Zealand according to the IRD in 2023, the general principle is that income related to loss of life or illness is exempt from taxation when directly received by individuals or estates, thus relieving beneficiaries of any tax obligations. Therefore, lump sum payments received from life, mortgage, critical illness, and funeral cover policies are typically tax-free, as are agreed value policies, which provide a predetermined payout amount.
Exceptions to this rule apply when the policy is owned by a trust or company rather than an individual. In such cases, the taxation guidelines may differ. For instance, if the trust is a ‘qualifying trust’ - meaning it’s established for the benefit of a person who has a physical, intellectual, or mental disability - then the payout is generally tax-free. However, if the trust is a ‘non-qualifying trust’, established for other purposes, such as estate planning, then the proceeds are subject to income tax.
Sound confusing? Your accountant or tax agent is going to be the best person to answer any questions. Pairing tax advice from your accountant with a Policywise insurance adviser can help you make sure you have the right life, health, and disability insurance cover structured in a way that will suit your needs.
Deductibility of premiums
In general, life insurance premiums paid by an individual are not tax deductible. However, those paid by an employer on behalf of an employee are tax deductible by the employer - in the same way that wage and salary costs are.
Is disability income insurance taxable?
Under current tax legislation, premiums payable for agreed value disability protection insurance are generally not deductible and claim payments are generally not taxable. However, this depends on the structure of your policy and may vary from insurer to insurer. If you mistakenly claim the tax back on your tax return, you can risk any proceeds from a claim now being subject to tax in the future, so it's important to get tax advice from your account or tax adviser before making any decisions.
Indemnity income protection insurance as a taxable earning
In taking out an indemnity income protection policy, you are generally eligible for a tax deduction by way of your personal income tax return, regardless of whether you are self-employed or employed.
However, any proceeds received from a claim are treated as taxable income meaning you will still need to pay taxes on those payouts, despite them being related to a loss of income.
Taxation of life insurance policies for employee and employer-paid premiums
Under the Income Tax Act 2007, life insurance policies taken out by employers for employees will have their premiums paid by the employer. These premiums are subject to fringe benefit tax (FBT). They will also generally be tax deductible.
The benefit received by the employee may be subject to pay as you earn tax (PAYE). This is a tax on non-cash benefits provided by an employer to an employee, such as the payment of life insurance premiums.
Loss-of-earnings/profits insurance tax deductions
In New Zealand, many individuals and businesses take out loss-of-earnings/profits insurance to protect themselves against potential financial losses due to unexpected events, such as illness, injury, or business interruptions. One question that often arises is whether these insurance products are tax deductible.
The answer largely depends on the purpose of the insurance policy. If the policy is taken out to generate assessable income, such as for a business owner, the premiums are usually tax deductible, which means the person can claim them as an expense in their tax return, reducing their tax payable or potentially creating a refund. The benefits, however, are regarded as income and, therefore, taxable.
GST on life insurance premiums
Goods and Service Tax (GST) is a consumption tax charged on the supply of most goods and services, including certain insurance products.
Most life insurance cover, such as life, mortgage, and funeral cover, is fully exempt from GST. However, GST is charged on premiums for some income protection policies. If you are GST registered, you may be able to claim the GST back, but it's important to get advice from a qualified tax adviser before deciding what you claim on. Making the wrong decision can result in any claim being subject to income tax at claim time.
It is worth noting that the tax applications and consequences on different types of insurance plans will vary. It can seem to be a complicated business, so working with a qualified accountant for the proper advice around this is imperative. It is also helpful to use a reliable and experienced insurance agent or broker, such as Policywise.
Policywise: your partner in making wise insurance decisions
Policywise is a 100% free service which tells you which health, life, and disability insurance provider best fits your needs. We offer fast, comprehensive, and easy-to-understand comparisons of all leading providers, and a simple summary clearly recommending which insurer is best for your situation.
Not all insurance policies are the same. Policywise can help you sort out the duds, avoid the lemons, understand the fine print and exclusions, and get the right insurance for you and your family.
We make the important decision of where to buy your insurance super easy. We’ll answer your questions, provide experienced advice, quotes, and comparisons, and manage all the back and forth throughout the application process. Taking out your cover through us means you'll have our lifetime support and claims advocacy, and we'll help you negotiate a positive outcome at claim time. We can also take care of lodging any claims on your behalf and back you up if the going gets tough.
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Conclusion
Understanding the tax deductibility of life insurance in New Zealand can be complicated. We’ve covered some key points, such as tax-free life insurance benefits, the taxation of life insurance for businesses, and the GST on life insurance premiums. However, this article is not intended as legal or tax advice; we recommend you seek professional guidance from both a qualified accountant or tax agent and your Policywise adviser to help you make informed decisions about all your insurance needs.