Are Insurance Policies Taxed?

Insurance policies have become essential to almost all aspects of life, from life itself to properties, to business, the list goes on.

Different insurance companies keep finding innovative offers and packages to get ahead of the competition and increase their customers.

This has made insurance, and the expertise needed to boost awareness very accessible and most times affordable.

Benefits received from insurance are exempted from taxation. This means that the beneficiary doesn’t have to pay tax. This is only logical as most times; these benefits are collected to cover for a loss or to foot a bill that will otherwise be financially overwhelming. However, sometimes benefits received from an insurance policy become liable for taxation.

Taxes from insurance are from proceeds that the government categorizes as income. And since the government taxes income, these proceeds become liable for taxation.

Below we look at instances where proceeds from insurance policies can be taxed.

• Income interest from life insurance

Every income you make from any venture is almost always taxable. This applies to income from the proceeds of life insurance. If, for instance, the death benefit is R1,000,000, but it yields a 10% interest before you receive it a year later. That R100,000 interest is taxable.

The R1,000,000 is however exempt from tax. So, avoiding taxes on life insurance, the beneficiary should strive to receive the proceeds as soon as possible. As a policyholder, do not arrange for the insurance company to hold the benefits so it can accrue interest before they pay the beneficiary.

• Estate and inheritance

This is one tax I attribute to poor decision-making. Some investors prefer to make their estates beneficiaries of contractual agreements like annuities, and life insurance policies. By making your estates your beneficiary, you eliminate the contractual advantage available to using an actual person as a beneficiary. 

You also subject that financial product (like insurance proceeds) to the probate process. By making your estate the beneficiary, you also increase its value, which could subject your heirs to exceptionally high estate taxes.

There are two ways to avoid taxation from estates and inheritance. I’ll share them below.

• Transfer of ownership

This is the first way to avoid taxation on inheritance and estates upon death. You can exclude proceeds from life insurance from these taxes by transferring the policy’s ownership to another person. To do this, note the following.

1. Choose a competent adult as your new owner and notify your insurance company of the intention to transfer ownership, and fill out the proper documents
2. The new owner has to pay the premium, but you can gift them the money they will use to pay the premium monthly.
3. You will lose all rights to change the policy henceforth
4. The ownership is irrevocable

• Irrevocable Life Insurance Trust

The second way to remove your insurance benefits from your taxable estates is by creating an irrevocable Life Insurance Trust (ILIT). You cannot be a member of the trust. You also may not revoke the trust.

One advantage of trust over having an individual as the new policyholder is that you may still have some legal control over the trust. Another advantage is that you are always certain that the trust will pay the premium.

• Health insurance

There are certain conditions for the proceeds of health insurance to be taxable. They involve health insurance schemes that are serviced by both the beneficiary and another party, for example, the beneficiary’s employer.

For an insurance policy that the beneficiary and their employer pay the premium, only the amount received that is because of the amount of premium paid by the employer is income. This amount is then considered for tax. If you however pay the full premium yourself as the beneficiary, then the proceeds will not be considered for tax.

If you pay for the premium but do not show the amount of the premium as taxable income to you, then the whole premium is taken to be paid by your employer, and the whole benefits become taxable. Always show the amount you pay as a premium for insurance policies.

Conclusion

Insurance policies have many advantages that make getting one a very logical and essential decision. Combining life insurance policy with other investments like retirement accounts, properties and savings ensure that in the end, you leave a sizeable estate behind. Taxes are one mechanism the government uses to generate the revenue needed for its proper functionality. 

Every responsible citizen expects to pay tax as part of their civic responsibility. However, as your investment and estates grow, there’s a tendency to face a significant tax issue in the future. By following the processes stated above, you will relieve yourself and your heirs from a significant amount of burden of tax.

Other Resources: Retirement Annuity | Professional Liability Insurance | Best Life Insurance Companies for Young Adults | 7 Types of Insurance Covers | Car Insurance | Health Insurance | Why Do You Need Income Protection Policy | Household Insurance Cover | Taxation of Insurance Policies | Choosing the Right Insurance Cover | Insurance Cover in SA