How is income protection taxed in Australia?
Income protection insurance offers a crucial form of financial protection for many Australians, providing an ongoing replacement income when you are ill or injured and unable to work. But if you’re wondering whether you can afford to pay income protection insurance premiums as part of your family budget, the good news is that those premiums are usually tax deductible. As a general rule of thumb here's how income protection is taxed in Australia:
- Premiums paid for insurance to cover loss of income are tax deductible (This includes income protection outside of super)
- Premiums funded via superannuation may not be tax-deductible
- Payouts are generally taxed if your benefits are in the form of income replacement
- Payouts are not taxed if the policy is inside super
However, any benefit you receive from an income protection policy must also be declared on your income tax return, so read on to discover all the ins and outs of income protection insurance and tax.
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When are income protection premiums tax deductible?
The Australian Taxation Office (ATO) explains that you can claim the cost of premiums you pay for insurance against the loss of your income. As long as your income protection premiums relate to earning an assessable income, and provided the policy is held outside of your superannuation fund, your premiums can be claimed as a tax deduction.
How much can I claim?
When you file your tax return, you can claim your income protection premiums as a tax deduction – but your tax refund will depend on your annual assessable earnings and the marginal tax rate that applies. Check the table below to get an idea of the tax deduction available to you.
|Policyholder’s Annual Earnings||Annual Premium to Insurer||Marginal Tax Rate||Tax Refund||Cost of Cover (after refund)|
|Between $18,201 and $37,000||$1,000||19%||$190||$810|
|Between $37,000 and $80,000||$1,000||32.5%||$325||$675|
|Between $80,001 and $180,000||$1,000||37%||$370||$630|
|$180,001 or more||$1,000||45%||$450||$550|
When are income protection premiums not tax deductible?
The ATO clearly spells out the situations when you will not be able to claim your income protection insurance premiums as a tax deduction:
“You can't claim a deduction for a premium or any part of a premium:
- for a policy that compensates you for such things as physical injury
- where the policy is taken out through your superannuation and insurance premiums are deducted from your super contributions.”
For example, you won’t be able to claim premiums for life insurance, trauma insurance or critical illness insurance as a tax deduction.
In addition, it’s worth remembering that your premiums will only be tax deductible if they relate to your ability to earn an assessable income, not if the policy provides cover of a capital nature. However, income protection insurance can often be bundled together with life insurance, which offers cover for ‘capital’ in the form of a lump sum payment if you die, and you may pay one premium for the entire policy. In this situation, only the part of the premium attributable to the income benefit (rather than the capital benefit) can be claimed as a deduction.Back to top
How do I claim a deduction?
Income protection premiums can be claimed just like any other work deduction on your income tax return. You can only claim a deduction for premiums paid in the financial year relevant to your tax return, and your accountant will be able to help you with this if you’re unsure of the process.
In cases where not all of the premium you pay is for income protection insurance, for example if you have life cover and income protection cover bundled together, you will need to apportion the premium between income and capital components. If you can’t show how much of your premium provided protection for your income and how much provided cover of a capital nature, the ATO may declare that the entire premium is non-deductible – so ask your insurer for help apportioning the premium amount.
Case Study: Kate Claims a Deduction
Kate is an accountant who earns $100,000 a year. This level of income means that she needs to pay the following in income tax: $17,547 plus 37c for each $1 over $80,000, which works out to be $24,947.
However, Kate also has income protection insurance cover in place, with her premiums set at $1,000 per year. This means her premiums can be claimed as a tax deduction, and a marginal tax rate of 37% means she can claim a deduction of $370.
Not only does this reduce the cost of income protection cover to $630 a year, it also sees her tax bill decrease to $24,577.
How are income protection benefits taxed?
According to the ATO, “You must declare any amounts you received for lost salary or wages under an income protection, sickness or accident insurance policy or workers compensation scheme.”
In other words, you’ll need to pay tax on the monthly benefits you receive just like you would on your regular income. The amount of tax you pay is determined by the amount you earn per year and the resulting tax bracket you fit into.
The tax table for the 2015/16 financial year is included below to help you determine your taxable income.
|Taxable Income||Tax on this Income|
|$0 - $18,200||Nil|
|$18,201 - $37,000||19c for each $1 over $18,200|
|$37,001 - $80,000||$3,572 plus 32.5c for each $1 over $37,000|
|$80,001 - $180,000||$17,547 plus 37c for each $1 over $80,000|
|$180,001 and over||$54,547 plus 45c for each $1 over $180,000|
Case Study: Tim Pays Tax on His Income Protection Benefits
Tim is a sole-trader plumber who earns $72,000 a year. Because he knows that his health is crucial to the success of his business, Tim has income protection insurance in place.
This proves to be a sound investment when, on August 1, 2015, Tim is seriously injured in a car accident. As Tim is unable to work, once he has been disabled for the 30-day waiting period his income protection insurance begins offering a monthly benefit of $4,500.
At the end of the 2015/16 financial year Tim is still receiving a benefit, but he needs to file his income tax return. His income is worked out based on the following calculations:
- Income from 1st month before injury: $6,000
- Income during waiting period: $0
- Income for remaining 10 months: $4,500 per month, totalling $45,000
Tim’s total income for the 2015/16 financial year is therefore $51,000, meaning he will be taxed at the following rate:
- $3,572 plus 32.5c for each $1 over $37,000
This means Tim’s tax bill will be $8,122 – minus any deductions he can claim, including the premiums he has paid for income protection cover.
Tax treatment of income protection inside superannuation
The details above apply to standalone income protection policies held outside of super, so what happens if you take out cover through your superannuation fund? The tax treatment gets a little more complicated and harder to understand, but you will not be able to claim your income protection premiums as a tax deduction. However, you will need to manage the cost of Pay As You Go (PAYG) withholding tax on any benefits you receive from your policy.
Conditions for self employed workers
However, it’s also worth remembering that if you’re self-employed, you may be able to claim your super contributions as a tax deduction – and as your income protection premiums are paid straight from your superannuation balance, this may work out to be a tax-effective strategy for you.
Finally, insuring through super may offer you tax advantages because your premiums are paid from your super and not from your own pocket – i.e., from your pre-tax income rather than your after-tax income. Income protection policies held through super do have a range of drawbacks as well, however, so take a closer look at insuring through super to decide on the best approach for you.Back to top
Income protection and fringe benefits tax
Another factor you’ll need to consider when shopping around for income protection insurance is Fringe Benefits Tax (FBT). Separate to income tax, FBT is paid by employers on certain benefits they provide to their employees. For example, benefits an employer may provide include giving an employee permission to use a work car for private purposes, providing a cheap loan to an employee, or paying an employee’s private health insurance premium costs.
When it comes to income protection premiums, whether or not FBT applies can be influenced by a number of factors. This can be explored in the example below:
In addition, in cases where income protection cover is used as a type of key person insurance and the benefit is used to replace the business’s income, FBT is once again typically not payable.Back to top
Some final questions you might have
Are income protection premiums tax deductible?
Yes. The portion of the premium that is paid to replace the loss of your income is tax-deductible.
Are benefit payments subject to tax?
Yes. Benefit payment are treated as income by the Australian taxation office and are therefore subject to tax.
Apart from possible tax benefits, are there any advantages to taking out income protection insurance through superannuation?
Yes, income protection through superannuation is usually cheaper than a standalone policy, can be taken out without having an impact on your monthly budget, and usually offers automatic acceptance.
Are there any disadvantages to insuring through super?
Yes. Superannuation income protection usually only offers a basic level of cover and limited benefit periods, doesn’t have tax-deductible premiums and may lapse if you move to another super fund.
How do I know the tax rate that applies to me?
The tax rates for the 2015/16 financial year are included above. Check with the ATO for future tax tables and changes to tax rates.
How much income does an income protection policy provide?
Most income protection policies provide an ongoing benefit to replace up to 75 per cent of your regular income. Maximum monthly benefit limits apply, for example $10,000, while the insurer will also put a limitation in the period for which you can receive a benefit.
I have an insurance policy that combines life cover and income protection cover – will my total premium amount be tax deductible?
No. You can only claim the portion of your premium that relates to earning an assessable income (i.e, your income protection cover) as a tax deduction.