Insurance premiums that you can gain a tax deduction from.
Taxation and Insurance Proceeds
Where the insurance proceeds are paid as a result of death, the taxation will depend on whether the death benefit is paid to a dependant or non-dependant. A dependant for tax purposes includes a spouse, child under 18 or financial dependant. Where a lump sum payment is made to dependants the payment is tax free up to the deceased’s pension RBL. When paid to a non-dependant it is taxable at a maximum of 16.5%. In both cases any excess above the deceased’s pension RBL is taxed at 48.5%. Generally, where a tax deduction was claimed by the super fund in respect of the premiums that funded the death benefit, a portion of the benefit would be an untaxed component. A lump sum payment containing an untaxed component when paid to a non-dependant is liable to a maximum tax of 31.5%. When paid to a dependant it is tax exempt provided it is non-excessive. As a result it can be beneficial to limit the amount of lump sum death benefits paid to the deceased’s pension RBL. In addition, it can also be beneficial to avoid paying a lump sum to a non-dependant that consists of an untaxed component. However where the trustee of the superannuation fund is able to pay a pension upon the death of the member, a combination of lump sums and pensions can be utilised to pay an amount exceeding the deceased’s pension RBL tax effectively.
A pension paid as a result of death is not assessed against the deceased’s pension RBL. Rather where the dependant is over 18 it is assessed against the dependant’s RBL. Where the dependant is under 18 it is not assessed against anyone’s RBL! Therefore it is possible for a dependant to receive an amount exceeding the pension RBL tax effectively by utilising a combination of a lump sum and a pension. This strategy is particularly effective where there is more than one dependant.
Tax deductable insurance Case StudyMr and Mrs Jones are aged 50 and 48 respectively. They have a financially independent daughter, Lucy (25 years old) and a son, Mark (16 years old). Mr Jones has accumulated superannuation benefits of $400,000 and life insurance through an employer-sponsored super fund of $1.5M. He is not eligible for a transitional RBL. Mrs Jones has a minimal amount of super. Mr Jones was involved in a fatal accident. Let’s assume the insurance premiums were tax deductible to the super fund, thus creating an untaxed component of say, $300,000 with the balance being all Pre/Post (taxed). How should the death benefit payment be structured?
1. Pay Mrs Jones a lump sum of $1,058,742
As Mrs Jones is a dependant for tax purposes she can receive up to her deceased husband’s pension RBL of $1,058,742 (2001/02) tax-free. This sum can be directed towards paying off the family’s non-tax deductible debts such as the home mortgage or re-contributed into superannuation as an undeducted contribution to take advantage of the concessional tax treatment (provided she meets the contribution rules). Please note that it is not possible to rollover these funds to superannuation.
2. Pay Mrs Jones an Allocated Pension of $436,732
The allocated pension will be assessed against Mrs Jones’ discounted lump sum RBL. As she is less than 55 years of age, her discounted lump sum RBL is $436,732 (ie the standard lump sum RBL of $529,373 reduced by 2.5% for every year she is under the age of 55). The allocated pension will be fully rebatable as it does not exceed her lump sum RBL.
3. Pay Mark an allocated pension with the remainder of $404,526
This allocated pension is not counted for RBL purposes, as it is payable to a dependant under 18 upon a member’s death. It is treated as fully rebatable, entitling Mark to a 15% tax rebate and is taxed at adult marginal tax rates. It will not be counted towards Mark’s RBL unless Mark commutes the pension outside the prescribed period at a later date.
4. What about Lucy?
As Lucy is over 18 and not a financial dependant she does not qualify as a dependant for tax purposes. If a lump sum was paid to Lucy it would be assessed against her deceased father’s pension RBL. Given that her mother has exhausted her deceased father’s pension RBL, the lump sum payment to Lucy would be all excessive and taxable at 48.5%!However, if Lucy’s mother were to split the lump sum payment with Lucy, the excessive tax penalty can be avoided. Although the lump sum payment to Lucy is not excessive, she will still be liable to tax at a reduced rate given her non-dependency tax status. If the lump sum contains the untaxed component of $300,000, Lucy is liable to a maximum tax of $94,500 (ie 31.5% x $300,000) on that portion. The balance of the lump sum payment is subject to a maximum of 16.5%.If Lucy were paid an allocated pension, she would be assessed against her discounted lump sum RBL of $132,343. If the purchase price exceeded $132,343, an excessive component would arise and she would not receive the full 15% rebate. Therefore, as a result of Lucy’s non-dependency tax status, it may be more tax effective for Lucy to receive part of the lump sum paid to Mrs Jones as it was paid tax-free. This amount could then be invested for Lucy according to her investment needs.
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