Taxation is never a clean and cut within the insurance industry, and that statement is even truer when we consider income protection insurance and payouts. To make matters even more confusing, the tax laws have taxed and untaxed insurance payouts in a back and forth manner over the last 20 years. Insurance policy payments are taxable, but the question continues about who is responsible for the money due under taxation.

At one point, it was the insurance company. At another time, it was the policy holder.  After much debate and struggle, the laws changed again in 2010, and the tax was raised on insurance companies. This was a reversal of sorts from the 1990 laws that decreased the amount that insurance companies were paying in taxes.

In regards to income protection insurance, sometimes the beneficiary is responsible for taxes on payment and sometimes they are not.  The problem is even more compounded because taxation is not individually specific.  It is dependent upon which type of policy you purchase. Some policies payouts are untaxed while other payouts are taxed as though they payment is income. That in and of itself is the crux of the problem.  Is the payment for income protection actually income?

Income Payouts

The problem for consumers is that income protection is designed to replace income that is lost when a person becomes unable to work due to most injuries or illnesses.  The payout for income protection is already reduced by 25%-45%. To be expected to pay taxes after receiving a 25%-45% reduction in income is difficult.  The idea behind income protection is to allow people who are unable to work, because of injury or illness, continue to pay rent or mortgages and live within their life style. That is rather difficult if someone loses up to 45% of their income and then is expected to be taxed on the remainder.

The solution is found within the types of policies that are available for consumers who are looking to protect their income.  Certain indemnity policies offer a payout at 55% of pre-disability income.  It is these policies that are often not taxed as income. Still that is not a very large concession if you are already facing recovery from illness or injury.  The policies that pay 75% of pre-disability income are usually taxed, though not always.  Again, it comes down to how the tax laws are being applied, and it is always a good idea to find out your own specific answer by talking with a tax professional.

Get Professional Tax Advice

One of the best pieces of advice is to sit down and talk with a tax professional who can help clear up this question. Sadly, there is not a blanket answer that covers everyone because income is such an individual matter.  A tax professional is usually the best bet for finding a solution that will protect income and save taxes.

Keep in mind that it is best to go through this process before you find yourself injured or ill.  The best thing to do is to compare your income to your expenses and then look at the scenarios that are available with each type of income protection policy available.  Policy choices are typically either an indemnity policy or an agreed payment policy but also make sure you read the policy to assess how long you will be paid out for.

Between the two are several customized policies, that are put together for competitive reasons between insurance companies. The New Zealand insurance market is still competitive which can help consumers who are looking for better prices. Again, it is important to look closely at the payout percentages because there is a wide gap in income between a payout that is 55% of your pre-disability income and 75% of your pre-disability income.

I suspect that as time goes on the tax laws will again change. It is, therefore, advisable to review your options on an annual or semi-annual basis. Insurance policies in general should be reviewed at least annually because our lives are never constant.

Since income protection insurance is designed to protect our income from loss if we are unable to work, it is important that people begin to prepare for the what-it’s. For most of us, our income is our greatest asset, and it is only prudent that we protect that asset as best we can.  Compare your income to your expense and then compare policies.  When in doubt, sit down with a tax professional and determine if your choice of income protection is likely to be taxed or not.  Crossing all of the T’s and dotting the I’s is the best any of us can do to see ourselves through the harder times in our lives.

 

(This article and all articles on this site are not to be taken as professional insurance or taxation advice and information may not be accurate, for insurance advice please speak to a registered insurance broker. We can connect you with a broker by using the form on this site.)