Whilst it is possible for a non-super income protection policy to be owned by a third party or jointly, rather than owned by the life insured, why would a client do this?

Fred and Anna are a married couple. Anna decides to take income protection on herself, but is advised to make Fred the policy owner for tax-deductibility purposes as he is on a higher marginal tax rate. Is this OK?

Income protection benefits are designed to replace the insured’s income. Section 8-1 ITAA 1997 allows a deduction for all losses and outgoings to the extent to which they are incurred in gaining or producing assessable income except where the outgoings are of a capital, private or domestic nature. This was confirmed by ATO ID 2001/405. However, there needs to be a sufficient connection between the purchase of income protection cover and the consequent earning of assessable income.

In Fred and Anna’s example above, there is clearly no link between the insured’s income and the policy owner’s proposed tax deduction. None of the premium would be tax deductible. Any monthly benefit due to a claim would be assessable to Anna at her marginal tax rate. Income protection policy proceeds are assessable even if the policy owner decides not to claim a tax deduction for the premiums (s6-5 ITAA 1997).

Both Fred and Anna are lives insured and joint policy owners in an income protection policy. They claim tax deductions in relation to their respective premiums (based on 75% of each person’s gross income). In this case, the ATO may allow their respective tax deductions, and the disability benefits would be assessable to the disabled policy owner. If there is a future marriage breakdown, however, both joint tenants would have to agree to any policy amendments. Yes, the spouses would save a policy fee, but self-ownership would be preferable.

Fred’s boss, Mr Slate, owns the Rock and Gravel Company. Fred takes out an income protection policy where he  s both life insured and policy owner. Because Mr Slate considers Fred to be an outstanding employee, he decides to pay Fred’s income protection premiums. The taxation implications are as follows:

• the premium will be tax deductible to the Rock and Gravel Company;
• the premium will not be subject to Fringe Benefits Tax (FBT) because the premiums would be otherwise deductible to Fred (sometimes referred to as the ‘otherwise deductible rule’
• the claim proceeds received by Fred will be subject to income tax; and
• the proceeds will not be subject to capital gains tax.

Premiums are also deductible to an employer and not subject to FBT where the income protection is used as a key person policy and the benefit is a form of income replacement to the business.

Summary

There are adverse tax consequences if a person who is not the life insured tries to claim income protection premiums as a deduction.
Income protection policies should be self-owned unless there is an appropriate business structure and relationship. Above all, individual insurers may also restrict the ownership in some of these scenarios and you should check with the underwriter first.

Contact Insurance Kings today to find out more information or apply online for your income protection policy.