Are Life Insurance Payouts Taxed?

Life insurance can provide a crucial safety net for your family and loved ones. Alongside choosing the right level of cover, many people also want to understand how tax may apply. In practice, tax treatment depends on the type of insurance, who receives the benefit, and whether the policy is held inside or outside superannuation.

There are two common tax questions that come up when considering life insurance and related covers:

• Are life insurance pay-outs (benefits) taxed?
• Are life insurance premiums tax deductible?

Before looking at those questions, it helps to understand the main types of cover that are often discussed together.

Four common types of insurance cover

Different policy types can pay benefits in different ways (for example, as a lump sum or as monthly instalments). These differences can also affect how tax is treated.

• Life insurance (term life insurance): This type of insurance can pay out a lump sum to your designated beneficiaries (typically a spouse or children) in the case of your death. Some policies will provide an early pay-out if you are living with a serious terminal illness.
• Total permanent disability (TPD) insurance: TPD insurance can pay out if you suffer an illness or injury that prevents you from working in any capacity. Benefits are usually made available to yourself and any beneficiaries in a lump sum, which can often help with rehabilitation.
• Critical illness insurance: Critical illness insurance can pay out if you suffer a serious medical event or illness. Examples can include 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 made up of monthly instalments—in case you’re unable to work due to sickness or injury.

Are life insurance payouts taxed?

Life insurance benefits are often tax-free, particularly when they are going to a financial dependent—such as a spouse or child. This is typically true for:

• Life insurance benefits paid in the case of death
• Critical illness insurance benefits
• Total permanent disability (TPD) insurance benefits

However, income protection insurance benefits are treated differently. Pay outs made under income protection insurance are unlikely to be tax free and are often taxed on a monthly basis.

Why “financial dependent” status matters

When naming an insurance beneficiary, it’s important to check your policy to establish who counts as a financial dependent. Spouses are commonly accepted, but there can be more restrictions around children over the age of 18. In many cases, children over 18 are often not regarded as financial dependents when it comes to receiving a lump sum.

This is a practical point to review when setting up or updating your beneficiaries, because the tax outcome can depend on whether the recipient is treated as a financial dependent under the policy and relevant rules.

What happens if life insurance is held through superannuation?

If life insurance is purchased through a super fund, the benefits will be paid to the trustee. This structure can affect the way the benefit is handled and distributed, so it’s another reason to understand how your cover is held when thinking about tax and beneficiaries.

Are life insurance premiums tax deductible?

Premium deductibility depends on the type of cover and whether it is purchased inside or outside superannuation. As a general guide:

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

Because these rules can vary by product structure, it’s important to distinguish between cover held personally (outside super) and cover held through superannuation.

Is life insurance through super tax deductible?

According to the ATO, life insurance taken out via super funds is not tax deductible. However, there is an exception that may apply for people 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 if purchased outside your super fund. This is because income protection insurance premiums are directly linked to your income.

Key takeaways to review in your own policy

• Many lump-sum benefits (life, TPD, and critical illness) are often tax-free when paid to a financial dependent.
• Income protection benefits are unlikely to be tax free and are often taxed on a monthly basis.
• Premium deductibility differs by cover type: income protection is usually tax deductible, while life/TPD/critical illness premiums are generally not deductible outside super.
• If your cover is held through super, benefits are paid to the trustee, and premium deductibility may differ—particularly for TPD held within super and potential SMSF exceptions for life cover.

If you are unsure how your policy defines a financial dependent, how your cover is held (inside or outside super), or whether a premium is deductible, checking your policy details is a sensible first step. For SMSF-related questions and any situation involving deductions, discussing your circumstances with an accountant or financial adviser may help clarify your options.