Income protection and tax (ATO rules)
Do you pay tax on income protection in Australia?
Income protection payments are taxed in Australia in the same way that your income is taxed. But there are several differences you need to be aware of. It all depends on what type of income protection you have, the payments you receive and your employment status.
Are income protection payments taxed by the ATO?
Yes. If you receive income protection payments from a successful claim, you will need to declare it to the ATO. As a general rule of thumb, here's how income protection payments are taxed in Australia:
- 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.
Keep in mind that if you are claiming multiple benefits for the same incident, typically only the benefits paid as an ongoing stream for income replacement purposes are tax assessable.
Compare Income protection policies
The ATO allows for the premiums of income protection held outside of super, to be claimed as a tax deduction. You can use our comparison table to find the right cover for you and claim the premiums back in your next tax declaration.
Are lump-sum income protection payments taxable?
Yes. In most cases, lump-sum income protection payments are taxed at your normal marginal tax rate. For a clearer idea of how much tax you will have to pay, you can use Finder's income tax calculator.
According to the ATO, you must declare any amount you have received for lost salary or wages under an income protection, sickness or accident insurance policy or workers compensation scheme.
The only time a payment might be tax-free is if you have made a personal injury claim and you agree to a settlement or a court orders in your favour and you receive compensation in the form of a lump-sum payment or periodic payment.
How are income protection payments 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.
2019-20 tax rates or Australian residents*
|Taxable income||Tax on this income|
|$18,201-$37,000||19c for each $1 over $18,200|
|$37,001-$90,000||$3,572 plus 32.5c for each $1 over $37,000|
|$90,001-$180,000||$20,797 plus 37c for each $1 over $90,000|
|$180,001 and over||$54,097 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.
2019-20 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-$90,000||32.5c for each $1|
|$90,001-$180,000||$29,250 plus 37c for each $1 over $90,000|
|$180,001 and over||$62,550 plus 45c for each $1 over $180,000|
How is income protection inside super taxed?
It's a little different, and more complicated, than taking out a standalone policy. In a nutshell, if you take out income protection through your superannuation fund,
- You will generally not be able to claim tax deductions for premiums and,
- The trustee of your super fund will apply withholding tax to benefit.
Speak to a tax specialist
The tax treatment can 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 you can 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 an effective tax strategy. Note that premium payments for insurance policies held inside superannuation may still count towards the tax-free super contribution limit.
Is income protection tax-deductible?
Generally, yes. The (ATO) stipulates that you can claim the cost of any payment made for insurance that covers you in relation to loss of income. This means that income protection insurance premiums are usually tax-deductible, but only if you buy it as a standalone policy. For more clarification, we've broken it down into the two ways you can get income protection.
- Outside super. Premiums paid for income protection insurance policies held outside of superannuation are tax-deductible.
- Inside super. For funds inside super, it's a bit trickier. Insurance policies held inside superannuation are not tax-deductible when insurance premiums are deducted from your super contributions. Full tax deductions are only available for self-employed workers.
How is income protection taxed if you are self-employed?
- Premiums. Income protection premiums are normally tax-deductible. The ATO views any payment you have made towards your regular income as tax-deductible. Your monthly benefit payments will be assessed (and taxed) as regular income. Keep in mind though that you can't claim expenses on any payments or benefits of a capital, private or domestic nature (e.g. accident, illness or death cover).
- Payouts. Payouts are generally taxed (at the marginal rate) if your benefits are to replace lost income and the premiums were deductible.
When can fringe benefits tax be claimed for income protection?
Separate to income tax, fringe benefits tax is a 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 policies that a business has taken out on an employee will be taxable as a fringe benefit in line with the premiums the employee could have expected to pay themselves for the same policy.
When won't fringe benefits tax be payable?
Income protection insurance premiums might not be susceptible to fringe benefits tax 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:
Michael works for a construction company and decides to take out income protection cover. He is named as the life insured and the policy owner, but because Michael is a highly valuable employee, his boss decides to cover the cost of Michael's premiums too. In this instance, Michael's boss may not have to pay any FBT on the premiums because they would be otherwise deductible to Michael.
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.
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