Have you just received an insurance payout? You may be wondering if you need to pay tax on this. We’re here to help. The tax implication of insurance can get a little complex in New Zealand, so we wrote this blog to help demystify the topic for you. We’ve covered which payouts are not taxable, which are, and some that are situation-dependent. Check it out!
A quick disclaimer – this blog is intended as a guide only and shouldn’t be considered tax advice. For definitive tax implications specific to your situation, get in touch with a tax specialist. This blog is aimed purely at personal covers only. The tax landscape can get a bit complex when it comes to business covers, so we’ve left that out of this article.
Not Taxable Insurance Payouts
Let’s start with the types of payouts you do not owe tax on: this includes lump sums, agreed value and mortgage cover. We’ve addressed the pros and cons of each below.
Lump Sums
- Pros: Lump sum payouts are usually not subject to income tax. This includes life insurance death benefits and critical illness lump sum payouts.
- Cons: There’s not really any cons in relation to tax. However, the payout amount may be affected by factors such as policy limits, premiums, and waiting periods.
Agreed Value
- Pros: Agreed value insurance policies provide a predetermined payout amount, which is not taxable. This can be reassuring for policyholders who are looking for certainty.
- Cons: Premiums for agreed-value policies may be higher compared to indemnity policies, which can make them less cost-effective for some people.
Mortgage Cover
- Pros: Mortgage protection insurance payouts, which help cover mortgage payments in case of disability or critical illness, are typically not taxed. This type of insurance isn’t necessarily limited to paying off the mortgage, as the sum insured can be up to 115% of mortgage payments. If you don’t have a mortgage, or you have a small mortgage and high income, you can opt to set your sum insured at a max of 40% of income.
- Cons: While term policies charge you fixed premiums for 30 years at a fixed cost, premiums on mortgage life insurance policies are a little different. They may only be fixed for the first 5 years, after which time they could spike at any time.
Taxable Insurance Payouts
Now let’s address which insurance payouts you do need to pay tax on in New Zealand. There’s only one, so it’s relatively simple.
Indemnity
- Pros: Indemnity insurance offers flexibility and potentially lower premiums compared to agreed value policies.
- Cons: Payouts from indemnity policies are taxable as income. The tax liability can vary based on your overall income and tax rate, which could potentially reduce the net payout.
Both Taxable and Not Taxable Insurance Payouts
Now, it’s not always black and white. For some payouts, you could be taxed or skip the tax. Let’s discuss disability income.
Disability Income
- Pros: Disability income insurance provides ongoing financial support during periods of disability. Some portions of the payout may be taxable, while others are not, depending on the policy’s structure.
- Cons: The taxable portion of disability income payouts can reduce the overall benefit, but the tax-free portion can provide essential financial support.
Another important note
Aside from just tax, you also need to be aware that some insurance payouts will affect your ability to receive certain government benefits like income support or disability payments. They can also impact estate planning and asset distribution after death. It’s best to talk to an expert about these implications, get in touch today.
Did you know?
As an employed person, if you pay income protection premiums, the premiums can be deducted against your personal tax return. The IRD believes that benefits on this policy are taxable. However, the premium costs are tax-deductible, which means you can claim this as an expense in your tax return – which could eventually lead to a big refund!
Confused? We can help
As you can see from the outline above, insurance payouts are not one-size-fits-all when it comes to taxation. It can very quickly get complex and at times confusing if you are not an expert in insurance. If you’re still feeling a little confused, get in touch with us on info@macdonaldwealth for a no-obligation chat to see how we can help you.
