Income Protection NZ Articles

To insure ... or not to insure

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And while taxation rarely forms part of this decision, the Tax Office will often be wanting their share of any compensation.

Where the compensation is to make good lost income it will be of a revenue nature and taxable to the recipient. 

Where the compensation is for the loss of destruction of a capital asset the compensation will have the unmistakable character of capital. 

In that case, it will only be taxable if caught by the capital gains tax ("CGT") provisions of the Tax Act.

Death Cover

Never a truer word has been uttered than by Benjamin Franklin when he said that there were only two certainties in life - death and taxes. 

When he spoke these words we doubt he contemplated taxation on death. 

Fortunately, the Tax Office also does not contemplate tax on death (in most circumstances). 

Losses as a result of death are capital in nature and, therefore, payments to compensate for these losses are almost always non-taxable. 

However, proceeds of death cover may be revenue in nature in limited circumstances, such as where they are intended to compensate a business for a temporary loss of income between the death of an employee and the employment of a suitable replacement.

Superannuation Death Benefits

Death benefits received from a Superannuation fund will not be taxable provided they are paid to a dependent of the deceased and do not result in the deceased exceeding their reasonable benefit limit. 

Where death benefits from a Superannuation fund are paid to a trust, or to the deceased's estate, they will be taxable under the eligible termination payment provisions. In this case, the commissioner has the discretion to treat the benefit as paid to a dependent and he will usually do so if he is satisfied that the money will ultimately be paid to dependents.

Accident and Disability

As a general rule, periodical payments made in substitution for lost wages, or which otherwise compensate for loss of income, are themselves of an income nature and taxable. 

On the other hand, lump sum compensation for the loss of earning capacity generally is a capital receipt, as the ability or capacity to earn income is a capital asset.

However, the answer may not always be so clear. 

Between these two extremes lie a range of possible outcomes.

The proceeds of a personal disability insurance policy, received as a series of periodic payments, are assessable where the purpose of the policy is to provide a periodic indemnity against income loss arising from the inability to earn. 

This is true even when there is no actual loss of earnings.

In circumstances where an accident or disability policy is taken out to provide compensation for the loss of an earning capacity and the recipient receives a lump sum payment, such a payment should not be assessable income to the recipient.

However, if the compensation is received as periodic payments then that, together with other factors, may change what would otherwise be capital amounts into income.

Trauma Policies

Trauma policies usually pay out a specified amount in a lump sum form. In such cases the pay-out is of a capital nature.

Where the compensation is in a different form, the taxation treatment needs to be determined having regard to the factors discussed above.

CGT

The CGT provisions do not generally apply when there is a pay-out under a life insurance policy. 

However, they do apply where the recipient is not the original beneficial owner and acquires the rights under the policy for consideration.

If the compensation is of a capital nature, it will be necessary to consider the CGT provisions. 

Compensation or damages received for any wrong, injury or illness suffered personally by the taxpayer or relative is also specifically exempt from CGT.

Death, Disability and Taxes

An event of death or disability is no time to discover that the Tax Office will be taking a hefty slice of any insurance proceeds.

There is no time like the present to consider the structure and nature of any insurance policies entered into, to ensure that the after tax proceeds of the policy are sufficient for your needs.

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