prepay-income-protection

Prepaying Income Protection Insurance for Tax Benefits

Did you know you can prepay income protection premiums for immediate tax benefits?

Income protection insurance is an important form of cover. This type of insurance pays out if you are unable to earn an income as the result of injury, illness or disability, and some policies can also include cover for redundancy and other involuntary unemployment.

Income protection also has potential tax benefits (as the premiums paid will often be tax-deductible) and you can even prepay your premiums to get immediate tax-deductions for the financial year.

DISCLAIMER: This article is general advice. It does not consider your own personal circumstances and may not be applicable to you. You should obtain professional advice and consider your own situation before acting on anything contained in our article.

How does pre-paying income protection for tax purposes work?

Prepaying your income protection for tax benefits involves two components:

  • Premiums being tax-deductible. The premiums you pay on life insurance are often tax-deductible.
  • Paying in advance. Pre-paying a number of premiums in advance (usually annually) to increase the deductible amount. Most policies should have enough flexibility to let you do so.

Why would I do this?

If you are near one of the major tax bracket thresholds in a given year, then claiming it as a deduction may push you into a lower tax bracket for that year.

Tax time coming up

Someone might already hold an income protection insurance policy where the premiums are being paid monthly. One year they sell some property which triggers capital gains tax. As a strategy to reduce tax, they might decide to prepay the upcoming year of income protection insurance premiums so they can claim it all as a deduction, which will help reduce their tax expenses.

  • If they don’t already have income protection insurance they might take out a policy and choose to pay premiums upfront (e.g. annually or quarterly), that the deductions are enough to put them below the tax threshold.
  • If they already have an income protection insurance policy they might choose to prepay the next year to maximise their deductions for that year.

What to consider before you pre-pay a years worth of premiums

The main consideration is whether or not your income protection premiums are tax-deductible.

1. When is income protection tax-deductible?

Generally, they are if it is an income protection insurance policy held outside of superannuation. Income protection insurance policies held through super funds may also be tax-deductible if you’re self-employed.

2. Are other forms of insurance tax-deductible, e.g. life insurance?

Typically the ATO will let you claim deductions for insurance that directly protects your ability to earn an income.

If you hold a combined life insurance policy with multiple cover types, such as a single policy that includes life, trauma, TPD and income protection insurance, then you may only claim a portion of the total premiums as a deduction, specifically the amount being paid only for the tax-deductible cover types. In this example, one would typically only be able to deduct the income protection portion, because life, TPD and trauma cover are not usually tax-deductible.

If this is the case, your policy document should have a breakdown of the premiums so you can work out how much you might be able to deduct. Otherwise it’s a good idea to get in touch with your insurer.

3. Working out whether it’s worth it

By prepaying your next 12 months of premiums you are bringing the next year forward to get an immediate deduction now. You'll also pay less on cover in total. However, the amount you could receive (in deductions) in the long run is less.

You might pay less in premiums, but also lower the total amount that’s deductible

For example, if you pay premiums monthly then over the course of 12 months you’ll still be able to claim the same amount as a tax deduction as if you’d paid it all annually. Should an insurance policy offer lower premiums for annual payments, compared to more frequent ones, you would actually be able to claim less as a deduction overall, because your premiums are lower.

Generally, it’s only worth doing this if you want to reduce your tax obligations for that particular year. For example, you might pre-pay the premiums as a one-off to compensate for unusually high taxable earnings in a given financial year, or might still pay premiums monthly or quarterly and have the full tax benefits year after year.

If you want to take advantage of this, it can be worth considering how different policies and insurance premium structures might affect it.

What to consider in a policy

The first thing to check is whether you are able to change your premium payment plan, whether there are any restrictions around doing so and what the options are. For example, a tax-deductible policy which only lets you adjust premium payment frequency at an annual renewal time might not give you the flexibility needed.

Naturally, the deductibility also depends on your premiums. This can vary widely over time depending on whether you select a stepped or level premium structure, and is also dependent on your cover level.

As such it may be worth looking at policies which let you adjust your cover, or otherwise adjust the options of a current policy in such a way as to impact the premiums.

Speak to a financial planner today about your personal circumstances

Rates last updated May 21st, 2018
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Andrew Munro

Andrew writes for finder.com, comparing products, writing guides and looking for new ways to help people make smart decisions. He's a fan of insurance, business news and cryptocurrency.

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