What tax rules apply to income protection 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. It’s important protection which is why the Australian government often permits tax deductions to be made from premiums paid for income protection insurance policies.
As a general rule of thumb here's how income protection is taxed in Australia:
Deductions (on the premiums you pay)
- Outside of super. Premiums paid for income protection insurance policies held outside of superannuation are tax deductible.
- Inside of super. Payments for income protection insurance policies held inside superannuation are not tax-deductible when insurance premiums are deducted from your super contributions.
Tax you'll pay (if you receive a payment)
- Outside of super. Payouts are generally taxed (at the marginal rate) if your benefits are to replace lost income and the premiums were deductible.
- Inside of super. Trustees will usually apply a 'withholding PAYG tax' from payouts for policies held inside super.
However, you must declare any benefit you receive from an income protection policy on your income tax return, so read on to discover all the ins and outs of income protection insurance and tax.
Reduce your tax expenses for the financial year
If you're looking for income protection or health insurance and also want to save on tax then make sure you read this post. Read more…
Read the guide to pre-paying income protection insurance for a tax benefits.
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 in deductions?
When you file your tax return you can claim your income protection premiums (for policies outside of super) as a tax deduction. The size of the tax refund will depend on your annual assessable earnings and the marginal tax rate that applies.
|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%||$191||$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|
This table does not include the Medicare levy (2%), and temporary budget repair levy (2% for incomes over $180,000).
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. With combined policies, you can still claim back the portion of premiums paid for the income protection component of your policy.
Some of the similar types of insurance that might seem like they’re not tax deductible, but actually are, include sickness and accident insurance policies and premiums paid by a business owner for workers compensation insurance.
These are tax deductible because although they pay for physical injury, they do not directly compensate physical injury and in fact insure one’s ability to earn an income. Similarly, ongoing income replacement benefits that can be paid out by those types of insurance are also tax assessable.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. If you’re unsure of the process it may be worth consulting an accountant or tax advisor.
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, ou will need to break it down into income and capital components.
If you can’t show how much of your premium provided protection for your income and how much provided cover is of a capital nature then you may not be able to claim deductions for any of it – so ask your insurer to help you break it down.
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: $19,822 plus 37c for each $1 over $87,000. In total this works out to be $24,892.
Kate's income protection
However, Kate also has income protection insurance cover in place outside of superannuation, for which she is paying $1,000 in premiums per year. This means her premiums can be claimed as a tax deduction.
With a marginal tax rate of 39% she can claim a deduction of $390.
Essential, Kate sees her tax bill decrease to $24,502 (from 24,892).
Note; that for the purposes of this example Kate is exempt from the Medicare Levy.
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.
2016-2017 tax rates or Australian residents*
|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|
|$87,001 - $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|
- *This table does not include the Medicare levy of 2%.
- *This table does not include the temporary budget repair levy of 2% on incomes above $180,000
2016-2017 tax rates for foreign residents
Individuals who are foreign residents for tax purposes can still get income protection insurance in Australia, and are subject to different tax rates. Foreign residents are not required to pay the Medicare levy, but may still be subject to the temporary budget repair levy.
Depending on the situation, foreign residents may be able to claim deductions for income protection insurance in similar ways.
|Taxable Income||Tax on this Income|
|$0 - $87,000||Nil|
|$87,001 - $180,000||$28,275 plus 37c for each $1 over $87,000|
|$180,001 and over||$62,685 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.
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?
- You will generally not be able to claim tax deductions for premiums.
- The trustee of your super fund will apply withholding tax to benefit.
Speak to a tax specialist
The tax treatment can also get more complicated in other ways, such as if you are not paying any of the premiums through superannuation contributions, are dividing premiums between super contributions and salary sacrifice, if your employer is making their own contributions to your premium payments, and other situations. Generally you will not be able to claim your income protection premiums as a tax deduction, but will need to expect Pay As You Go (PAYG) withholding tax to be applied to any benefit payments you receive from your policy.
Exceptions for self employed workers
If you’re self-employed you may be able to claim your income protection insurance premiums as tax deductions even when held inside a superannuation policy. Because these premiums can be paid straight from before-tax superannuation contributions, this might work out to be a tax-effective strategy. Note that premium payments for insurance policies held inside superannuation may still count towards the tax-free super contribution limit.Back to top
Income protection and fringe benefits tax
Another factor you might need to consider when shopping around for group income protection insurance, such as if you’re an employer looking to provide insurance for workers, is Fringe Benefits Tax (FBT).
What is fringe benefits tax?
Separate to income tax, FBT is business tax paid by employers on certain benefits they provide to their employees. Fringe benefits might include giving an employee permission to use a work car for private purposes, or contributing to income protection insurance premiums for a policy taken out on an employee. Typically, fringe benefit tax for life insurance type policies taken out by a business, on employees, will be taxable as a fringe benefits in line with the premiums the employee could have expected to pay themselves, for the same policy.
What won't fringe benefits tax be payable?
Income protection insurance premiums might not be susceptible to FBT where the “otherwise deductible” rule applies. Essentially, this means that when someone else could be claiming a deduction for the same expense, FBT will not apply to the relevant portion.
Consider this example where FBT will not apply at all:
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