Are life insurance payouts taxed?

Life insurance is often taken out to provide a financial safety net for family and other loved ones. Alongside choosing the right cover amount and policy features, many people also want clarity on tax: are payouts taxed, and can premiums be claimed as a deduction?

Two questions tend to come up most often when discussing life insurance and tax. The first is whether taxes apply to insurance pay-outs or benefits. The second is whether the premiums you pay (monthly or annually) can be tax deductible. The answers depend heavily on the type of cover and, in some cases, how the policy is held.

Four common types of cover

Insurance products that are often discussed together can work quite differently. Understanding the broad categories can help you make sense of how payouts and premiums are typically treated.

• Life insurance (also known as term life insurance): This cover can pay a lump sum to your designated beneficiaries (often a spouse or children) if you die. Some policies may provide an early payout if you are living with a serious terminal illness.
• Total permanent disability (TPD) insurance: This can pay out if you suffer an illness or injury that prevents you from working in any capacity. Benefits are usually provided to you and any beneficiaries in a lump sum and can help with rehabilitation.
• Critical illness insurance: This can pay out if you suffer a serious medical event or illness, such as a heart attack, stroke, or paralysis. It is often used to help pay for medical treatment, rehabilitation, and recovery.
• Income protection insurance: This type of insurance can provide a benefit—often monthly instalments—if you are unable to work due to sickness or injury.

Are life insurance payouts taxed?

In many cases, life insurance benefits are often tax-free, particularly when they are paid to a financial dependent, such as a spouse or child. This is typically true not only for life insurance paid in the event of death, but also for benefits paid under critical illness insurance and TPD insurance.

However, income protection insurance is treated differently. Pay outs made under income protection insurance are unlikely to be tax free and are often taxed on a monthly basis. Because income protection commonly pays an ongoing benefit rather than a lump sum, the tax treatment is often considered separately from other types of cover.

Why “financial dependent” matters

Whether a payout is tax-free can depend on who receives it and whether they are considered a financial dependent under the policy and relevant rules. When naming an insurance beneficiary, it is important to check your policy to establish who counts as a financial dependent.

Spouses are commonly accepted as financial dependents. The position can be more restricted for children over the age of 18, who are often not regarded as financial dependents when it comes to receiving a lump sum. This is one reason beneficiary nominations and policy definitions are worth reviewing carefully.

What if the policy is held through super?

If life insurance is purchased through a super fund, the benefits will be paid to the trustee. This structural detail is important because it affects how the benefit is handled and distributed, and it can also influence the practical steps your beneficiaries may need to take at claim time.

Are life insurance premiums tax deductible?

Premium deductibility is a separate issue from whether a payout is taxed. In general, the deductibility of premiums depends on the type of cover and whether it is held inside or outside super.

• Life insurance, critical illness, and TPD insurance purchased outside super are generally not tax deductible.
• TPD insurance purchased within super is tax deductible.
• Income protection insurance is usually tax deductible regardless of how you purchased it.

Is life insurance via super tax deductible?

According to the ATO, life insurance taken out via super funds is not tax deductible. There is, however, an exception that may apply to those with a Self Managed Super Fund (SMSF). If you have an SMSF, you may be able to tax deduct your life insurance premiums, and it is best to discuss your options with your accountant or financial adviser.

Is life insurance outside super tax deductible?

Typically, no. Life insurance against death, TPD, or critical illness isn’t tax deductible even if purchased outside superannuation. One notable exception is income protection insurance purchased outside your super fund. This is because income protection insurance premiums are directly linked to your income.

Key takeaways to keep in mind

• Life insurance, TPD, and critical illness benefits are often tax-free, especially when paid to a financial dependent.
• Income protection payouts are unlikely to be tax free and are often taxed monthly.
• Premiums for life insurance, critical illness, and TPD held outside super are generally not tax deductible.
• TPD held within super is tax deductible, while life insurance via super is not tax deductible under ATO guidance (with a possible SMSF exception).
• Income protection premiums are usually tax deductible, whether held inside or outside super.

Because definitions (such as “financial dependent”) and ownership structures (such as holding cover through super) can influence outcomes, it’s worth checking your policy details before relying on a general rule of thumb.