With the cost of living on the rise, it’s more important than ever to have a financial safety net that protects you and your family in case the unexpected happens.
Most Australian employees have some form of life insurance, often through their superannuation fund, but many of us tend to ‘set and forget’.
To make the most of your life insurance policy, it’s useful to understand how it works, and how premiums and payments are affected by tax.
Various types of life insurance
Life insurance is an umbrella term for a range of policies that cover different situations. They include:
- Life cover, which pays out after your death to someone you have nominated.
- Income protection covers you if you’re unable to work because of illness or injury.
- Total and permanent disability (TPD) insurance provides medical and living costs if you become permanently disabled.
- Accidental death and injury cover pays a lump sum if you die or are injured.
- Critical illness or trauma insurance pays a lump sum to cover medical expenses for major medical conditions.
- Business expenses insurance covers ongoing fixed business costs if you’re a business owner suffering serious illness or injury.
Tax benefits and deductions
The premiums for most types of life insurance are not tax deductible, but there are exceptions. Premiums for income protection held outside of super are tax-deductible and inside super for the self-employed. Business expenses insurance premiums are also tax deductible.
The tax treatment of benefits paid out by policies also varies according to the type of policy and your situation, so it’s important to talk to us. Generally, life cover paid to someone who’s financially dependent on you (typically a spouse and children under 18 years) is not taxed. But if the beneficiary isn’t your financial dependent, they can expect to pay tax.
Income protection insurance payments must be declared on your tax return and will be taxed at your marginal rate, just like your usual salary. Business expense insurance payouts also taxable.
Lump sum payments made through other policies are not taxable.
Inside super or outside?
Some of these insurances, particularly life cover, income protection and TPD, can be purchased through your super fund. Most people have a basic level of cover held this way, but you should check to see if it’s adequate for your needs.
If you are aged under 25, have a super balance of $6,000 or less, or your account is inactive, you will need to “opt in” if you want insurance cover.
If you have a self-managed super fund (SMSF), you’re required to consider whether to hold life insurance for each of the fund’s members, although there’s no obligation to buy.
Super pros and cons
You’ll need to do the sums for your circumstances, which is where an adviser can assist, but there may be an advantage to using your super to pay the premiums. The main reason is cost.
Sometimes, the buying power of larger super funds allows them to negotiate competitive pricing for insurance products. It’s not always the case, so you’ll need to shop around to make sure you’re getting the best deal.
Another potential financial benefit in paying the monthly premiums out of your super account, is that you’re using funds taxed at 15 per cent. Whereas, if you pay the premium from your own bank account, you’d be using funds already taxed at your marginal tax rate, which may be higher. That means your pre-tax dollars are working harder and you’ve still got your cash in the bank.
The main drawback to paying insurance premiums through super is that you’ll be reducing your super balance, which means less for retirement. However, you could choose to boost your balance using salary sacrifice or personal contributions.
Your safety net checklist
- Decide on who and what needs to be financially protected if something should happen to you.
- Weigh up the best type of life insurance to meet your needs and shop around.
- Be clear about any tax implications of an insurance payout
- Make sure the policy benefit is adequate and check it annually.
Deciding on the type of life insurance you need can be tricky, so give us a call to discuss your insurance needs on myadviser@moneyclip.com.au or 02 9299 2292