The short answer: depends.

The longer answer: maybe, maybe not.

No I am not trying to be difficult, it does depend on the policy you have so maybe, maybe not.

The simple answer:

If you have indemnity or loss of earnings yes, it is tax assessable. If you have agreed value, it is generally not tax assessable. But there's more, no not a set of steak knives, really there's more.

Why this is not as simple as you would think:

In New Zealand, we have several pieces of legislation that impact tax on income protection policies.

Legal point 1

The first is the legislation that applies to indemnity or loss of earnings policies. This says where the claim payment is directly due to the loss of income at the point of loss (claim), then it is deemed to be replacement of income and it is tax assessable. 

Legal point 2

The second piece of legislation, for personal sickness and accident policies, covers agreed value polices. What this says is; where the amount of the claim is defined before the claim and not directly relating to a loss of income at point of claim, then the policy is paid without being subject to tax.

Therefore, for agreed value where the amount of cover is defined at point of application, at claim time the trigger for the claim payment is the inability to work not the loss of income, making the agreed value claim payment not tax assessable.

Legal point 3

The third piece of legislation, which relates to agreed value more so as indemnity and loss of earnings are already tax assessable. This is the deductible assessable rule. If you take a tax deduction on a policy, the proceeds of that policy become tax assessable. If you took a tax deduction on your agreed value income protection or any other benefit for that matter, then the claim on that benefit will be assessed for tax.

Where the fun begins

This last one is the one that gets people in trouble. Primarily because advisers advise on polices based on claims not being tax assessable, with the exception of indemnity and loss of earnings income protection. Because the advice is net in the hand, when you take an unintended tax deduction, at claim time because it is being taxed, there is no longer enough money to do the intended job.

Dollars now vs the practical frustration

As an adviser, this is frustrating at times. Either take the right level of cover and do not take the tax deduction, or take a higher level of cover to account for tax, if you intend on taking a deduction. Do not take the lower level and expect the outcome to be ok when you have deducted tax.

Either way, we can arrange for it to be deductible if you wish. We will be paid better, your accountant will charge you for doing it, and the tax department will appreciate the extra funds at claim. For you there is no net advantage by taking the higher cover so you can take the deduction, as your premium will likely end up the same as will your claim.

Things to consider

If you are not taking a tax deduction on your indemnity or loss of earnings policy then you are paying more for your cover than you need to. If this is the case then talking to us about an agreed value option, will make things simpler for you and likely save you some money.

There are some agreed value policies in the market that are designed to be deducted and do insure for tax. Some are positioned to use the deductible assessable rule, you deduct then it is taxed. Some are subject to the deductible rule and the income protection legislation as they are a hybrid of loss of earnings and agreed value.

Call us

If you do not know what you have or you are unsure, it might pay to give us a call and we can clarify this for you.