Is income protection tax deductible?

The answer to this question usually depends on whether the policy has a tax-free pay-out. However, there are other factors to assess as well. Here’s a handy introduction to insurance premiums and tax, including premiums paid by an employer for their employees.

When the pay-out is taxable, premiums are tax deductible

If you have to pay tax on a benefit paid out by the insurance policy, then the cost of the premiums is tax deductible. This is usually the case when the benefit is calculated as a percentage of your income over some period before you made a claim. The benefit payments would clearly be replacing your lost income, so they’d be seen as part of your annual income and therefore taxable.

These types of policies are usually called ‘loss of earnings insurance’ or ‘indemnity insurance’. They typically pay you a reduced monthly income if you’re unable to work due to illness or injury. There’s usually an agreed wait period before the payments start and a maximum time over which the payments can be made.

When the pay-out has a previously agreed value, premium are not tax deductible

If the amount to be paid out is specified in your policy before you make a claim, it’s known as ‘agreed value cover’. That means the pay-out is not related to your lost income. Instead, it’s simply related to the fact that you can’t work. Since it’s not seen as replacing your taxable income, you usually don’t have to pay tax on the benefit. That means you can’t claim the premium payments as a work-related expense or tax deduction.

What happens if you claim when you shouldn’t?

If you do make a tax claim for the cost of premiums paid on an agreed value policy, you will change its status. You’ll now have to pay income tax on any benefit the policy pays out. In other words, you can’t have it both ways. You can’t claim tax on the premiums and not pay tax on a pay-out from that policy. That’s why it’s important to get tax deductibility right. Having to pay tax at your highest rate could greatly reduce the cover you thought you would receive.

If you’re not sure whether you would have to pay tax on an insurance policy’s benefit, just ask your insurer. Then you’ll know whether you can claim the premiums as a tax deduction.

What about claiming mortgage repayment insurance premiums?

In New Zealand, benefits paid out from mortgage repayment insurance are tax free. That means you can’t claim the premiums as a tax deduction.

Most mortgage repayment policies pay a previously agreed monthly sum if you can’t work due to injury or illness. You choose the payment amount when you take out your policy. The maximum allowed is usually something like 40% of your monthly income or 110% of your usual mortgage repayments. Even though it’s paid monthly and you’re free to spend the money on whatever you choose, it’s not considered an income. That’s because it’s based on an agreed value and not determined by your income in the period before you make a claim.

What if I pay for my employees’ income protection insurance?

This can get complicated, so it pays to get advice from a professional tax specialist. In the meantime, here are some tips about the more straightforward situations.

If the employee owns the policy

An employer can usually claim the cost of the premiums it chooses to pay on an employee’s behalf.

  • If the policy is purely income protection insurance, the premiums paid are not part of the employee’s PAYE taxable income, but any benefits paid to the employee resulting from a claim are taxable. Fringe benefit tax does not apply because the policy is owned by the employee.
  • However, for an agreed value policy (not based on loss of earnings) the premiums paid by the employer are treated as salary or wages and therefore subject to PAYE for the employee. Any benefits paid by the policy are tax free. Fringe benefit tax does not apply.

If the employer owns the policy

If an employer takes out an insurance policy in its own name to cover employees, fringe benefit tax usually applies and is paid by the employer. The fringe benefit tax is based on the value of the premiums paid by the employer, not any pay-outs resulting from a claim. In some cases premiums paid need to be allocated to each employee and their total remuneration when calculating the fringe benefit tax.

To learn more

For more on tax and insurance premiums, talk to a tax specialist or visit the Inland Revenue website.

To find out more about the types of insurance mentioned in this article, see our complete guides to:

DISCLAIMER: The information contained in this article is general in nature. While facts have been checked, the article does not constitute an insurance advice service. It is only intended to provide education about the New Zealand insurances sector. Nothing in this article constitutes a recommendation that any type of insurance cover is suitable for any specific person. We cannot assess anything about your personal circumstances, all of which are unique to you. Before making insurance decisions, we recommend you seek assistance from an insurance adviser or expert.

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