Taxes, Life insurance and Income protection
Over the last two articles, we’ve talked about protecting your greatest asset: you. As part of this discussion we need to now talk about the tax consequences of entering into these financial products as well as what you can expect, should you or your family need to call on them one day.
Most people associate income tax with life insurance or income protection, with a gloat about what kind of deduction you can get and how large your refund from SARS will be – everyone seems to “know a guy” who can get you money back from SARS.
Although getting a potential and immediate tax deduction for paying life insurance premiums or an income continuation policy has merit, you should consider how SARS might take their share if your policy ever starts paying out. The last thing you’d want to happen is to expect a certain lumpsum or annuity amount, only to have a large chunk shaved off.
The taxation of these insurance policies has undergone some recent change, so now is also good time for you to get on top of those changes, whether you have existing insurance or will be considering some in the months to come.
One last thing before we get stuck in…
We feel it very important to stress upon you that ‘letting the tax tail wag your financial plan dog’ is a bad way to go about things. What we mean by this, is that there are far more important economic, social and personal reasons for undertaking most steps in your personal finance journey than worrying about the immediate tax outcomes.
Choosing not to take out life cover because you won’t get a deduction for the premium paid or grumbling like your grandfather about how “SARS has taken enough of my blimmin money already” is short-sighted.
There will be times where you can legally and legitimately do things in a particular manner to take advantages of tax concessions made by SARS, but choosing to not do anything at all because there is no apparent tax benefit is ludicrous.
WellSpent thinks TaxTim is so amazing that we recommend it to all our friends and family. They offer an ingenious service, whereby you can complete your tax return through their super easy-to-use website, and have it submitted directly to SARS! We don’t want to write much more about TaxTim, as they’re better at explaining how their product works. Give their site a visit here. Suss out the nuts and bolts, and don’t forget your 10% discount voucher – WELLSPENT19
No deduction, no taxation
Our legislation dealing with the tax on policies for death, disablement, severe illness or unemployment has thankfully been streamlined. The outcomes are also all the same regardless of the type of policy which makes understanding it all pretty straightforward.
If you receive any benefit under a policy of insurance covering the above types of events, you or your beneficiaries will not be taxed on that amount – simple as that.
This means that should your spouse currently stand to benefit under a life insurance policy to the value of R5 million and should you die, your spouse will receive precisely that, with the full R5 million being exempt from tax.
The same goes for a policy protecting you against a loss of income. All amounts received both as an annuity or a lumpsum will be free from tax.
Here comes the “but”…
The problem, however, is that if you contribute a monthly premium to a policy of this nature, you will get no deduction for such premium. This means that there is no way to reduce your annual tax liability by paying premiums on these policies.
This is generally how our tax legislation works. If the amounts are tax-free down the line, you don’t get a deduction now. If you get to claim the deduction from your annual tax charge, expect to pay tax on the proceeds in the future.
This treatment stands for both new policies and old ones. People who had in the past received tax deductions for the contributions to these types of policies are still afforded the same exempt status on their future payouts.
Hopefully much of muchness
Some people would rather get a deduction now for their premium, than get a tax-free amount in the future. After all, insurance is a grudge purchase, so whatever relief they can get now, appears to make all the sense in the world.
The theory is however, that since these future amounts are now no longer subject to tax, many people may be over-insured. Imagine if you decided that you need R30, 000 per month to replace your income should you no longer be able to work. You knew SARS would take some of that away, so you took out cover for R40, 000 per month.
If you had to claim on that cover now, you’d be getting more than you needed as you’d receive all amounts tax free. What may happen over time and as people re-assess their insurance needs in relation to their life and disability cover is that they will reduce the value of their cover, which will in turn bring down their premiums.
Some people are so fixated on getting a deduction for the premium now, that they’d choose to not consider taking out the insurance at all.
If you have existing cover, we’d suggest that you speak to your financial advisor to ensure that you are not perhaps over-insured. Maybe even an opportunity to save a few hundred rands per month?
The money or the box
Something else to be aware of: if you elect to receive a lumpsum from your income continuation policy, that lumpsum will be free from tax as discussed above. What won’t be free from tax, will be the income that gets generated from that amount based on how you invest it. Compare this to rather electing to receive an annuity from your insurer and receiving all amounts tax-free. All the more reason to consult a financial advisor when considering these products to help you make the correct decision around your cover.
Dance with the taxman in the pale moon light.
Over the coming months we will deal with tax as it relates to various aspects of your financial journey. Sometimes just to help you stay on the straight and narrow with SARS.
Sometimes it will be to help you arrive at tax-efficient outcomes, where you have some options to work with, and occasionally we’ll even perform some pretty complex and cool calculations to take your financial journey from mediocrity to well-informed.
We’ve written quite a few other great pieces on how tax affects your various investments and retirement outcomes – here they are:
- Paying tax when retired
- Tax on units trusts
- Tax on retirement annuities explained
- Tax on interest
- How to pay less tax in South Africa
- Should I get a tax-free savings account?
- Tax on provident fund withdrawal benefit
- The quest for the highest after-tax return
If you have any questions on any of them, give us a shout!