Are life insurance payouts taxed?

Life insurance can provide a crucial safety net for your family and loved ones, but is it subject to tax? This quick guide will help clear things up. 

When considering life insurance and tax, there are two key questions. The first is whether taxes apply to life insurance pay-outs or benefits, and the second is whether life insurance premiums can be tax deductible. We’ll start by briefly outlining the four main types of life insurance.

What are the different types of life insurance?

Life insurance (in case of death) 

Also known as term life insurance, this type of insurance can pay out a lump sum to your designated beneficiaries (typically a spouse or children) in the case of your death. Some policies will provide an early pay-out if you are living with a serious terminal illness. 

Total permanent disability (TPD) insurance

TPD insurance can pay out if you suffer an illness or injury that prevents you from working in any capacity. Benefits are usually made available to yourself and any beneficiaries in a lump sum, which can often help with rehabilitation.

Critical illness insurance
Critical illness insurance can pay out if you suffer a serious medical event or illness. This might include things like a heart attack, stroke or paralysis. It is often used to help pay for medical treatment, rehabilitation and the road to recovery. 

Income protection insurance

This type of insurance can provide a benefit – often made up of monthly instalments – in case you’re unable to work due to sickness or injury. 

Are life insurance benefits (pay-outs) taxed?

Life insurance benefits are often tax-free, particularly when they are going to a financial dependent – this could be your spouse or child. This is typically true for life insurance (in case of death) as well as critical illness insurance and total permanent disability insurance. However, pay outs made under income protection insurance are unlikely to be tax free, and are often taxed on a monthly basis. 

When naming an insurance beneficiary, you will need to check your policy to establish who counts as a financial dependent. Spouses are commonly accepted, but there are more restrictions around children over the age of 18, who are often not regarded as financial dependents when it comes to receiving a lump sum. If life insurance is purchased through a super fund, the benefits will be paid to the trustee.
Now to answer whether life insurance premiums (monthly or annual fees) can be deducted from your tax.

Which types of life insurance are tax-deductible?

Generally:
● Life insurance, critical illness and TPD insurances purchased outside your super are not tax deductible. 
● TPD insurance purchased within your super is tax deductible. 
● Income protection insurance is usually tax deductible regardless of how you purchased it. 

Is life insurance tax deductible when obtained through of superannuation?

According to the ATO, the answer is no. Life insurance taken out via super funds is not tax deductible. However, there is an exception to be explored for those with a Self Managed Super Fund. If you have a Self Managed Super Fund, you may be able to tax deduct your life insurance premiums, and it is best to discuss your options with your accountant or financial adviser. 

Is life insurance tax deductible if I get it outside of superannuation?

Again, the answer here is typically no. Life insurance against death, TPD or critical illness isn’t tax deductible, even if purchased outside superannuation. One notable exception here is income protection insurance if purchased outside your super fund. This is because income protection insurance premiums are directly linked to your income. You can learn more about the different considerations when claiming tax deductions on insurance premiums here.