What you need to know about Income Insurance Claim Payments to Avoid A Tax Bill

Do you know if your Income Insurance Claim Payments are Taxable?

The answer is 'Yes, they are' so don't get caught at tax time with an unexpected tax bill!

Life insurance companies are very quick to tell you that your Income Insurance premiums are fully tax-deductible whether you pay the premium, or your employer pays the premium on your behalf.

Unfortunately, most people are not aware that any Income Insurance claim payments received are taxable, and therefore the recipient of the payment will be liable for any tax payable.

If you are an employee, you will be familiar with receiving your income after the tax has been deducted.

If you have ever received an Income Insurance claim payment, you would have noticed that the life insurance company DOES NOT deduct tax from the payment which may cause you to have an unpleasant surprise at the end of the Financial Year when your tax adviser informs you of the tax bill you have to pay!

Just to add another level of complexity, the amount of tax you will have to pay on an Income Insurance claim payment is dependent on a couple of significant factors such as:

• How much taxable income (e.g. your employment income; bank account interest; rental property income; etc) you received in the Financial Year in which you also received the Income Insurance claim payment
• How much tax was paid on your behalf to the tax office (e.g. tax deducted by your employer from your employment income)
• The Income Insurance claim payment that was received

For the purpose of illustrating the impact of taxation on Income Insurance claim payments, I have prepared the following scenario for your reading pleasure:

Assumptions of Bob's Income Insurance Claim

• Bob is married to Jane, and they have two dependent children Tommy and Mary
• Bob has no HELP/HECS debt, and Bob and Jane have Private Health Insurance
• Jane does not work (Jane says raising Tommy and Mary is enough work for her, thanks very much.and Bob is not one to argue with Jane)
• Bob is employed as a Sales Representative, with a gross annual salary of $75,000 plus $7,125 employer superannuation contributions (calculated as 9.50% of gross annual income)
• Bob's after-tax employment income is $57,578 annually
• Bob was insured for 75% of the total of Bob's gross income plus his employment superannuation contributions (equating to a total Insured Benefit of $61,594 per year)
• Bob and Jane have no other taxable income (e.g. they do not have a rental property, and no significant cash savings they have two children "assets", and that's enough!)
• Bob and Jane's family living expenses are about $55,000 annually
• Bob seriously broke his ankle whilst playing soccer with Tommy and Mary on the family's Christmas vacation (Bob had not run for a very long time, but in Bob's own mind he is still 25 years old and can run like the wind Jane, of course, does not agree)
• Bob was told by his family doctor that he would not be able to work for six months, after his ankle surgery, as he would be unable to drive whilst recovering and rehabilitating his ankle
• Bob submitted his Income Insurance claim, and luckily Bob's Financial Adviser recommended he add the optional "Day One Accident" Benefit to his Income Insurance policy (because Bob and Jane's family expenses were pretty much the same as his after-tax employment income)
• Bob's insurance company paid his claim from 1 January 2016 to 30 June 2016 (lucky Bob! Although Jane was not convinced having Bob home for six months was great news.)

The scenario assumes the events took place in the 2016 Financial Year, during which Bob had worked from 1 July 2015 to 31 December 2015, and received his income insurance claim payments from 1 January 2016 to 30 June 2016 (the writer would like to thank Bob for making the dates so easy to complete the calculations for this scenario!)

The following table summarises the calculations for Bob's Income Insurance claim payments, including tax and superannuation implications:

As is evident in the calculations, during the claim, the total after-tax income will not meet the family's pre-claim living expenses, but only by a small margin ($1,822), which is not likely to cause any significant issues for the family, as the total living expenses are likely to be lower during the time Bob is not at work (less work related expenses such as vehicle fuel, lunches, etc.).

It is worth noting however, the total income Bob had lost by not being able to work for six months of the Financial Year was a total of $7,953, which was not just lost employment income, but the lost employer superannuation contributions.

In summary, it is vitally important that you understand exactly what income and expenses, including tax, you are likely to have in the event of an Income Insurance claim, and make sure the after-tax Income Insurance claim payment is likely to be able to meet your living expenses whilst you are on claim.

If you are unsure as to your own particular circumstances regarding Income Insurance, please do not hesitate to contact my office and arrange a FREE FINANCIAL ASSESSMENT APPOINTMENT because #everyoneneedsaplan to ensure they can meet their expenses if they are unable to work.,