Life assurance companies have responded differently to the change in how income protection policies are taxed, which took effect at the beginning of this month, and you should know how this could affect your finances.
Income protection policies provide you with a monthly income if you become disabled.
How your life assurer deals with the change could:
* Affect your take-home pay at the end of March;
* Boost your income protection benefits if you claim;
* Result in an immediate reduction in your premiums and benefits;
* Result in you eventually paying more for cover; or
* None of the above.
The Taxation Laws Amendment Act of 2014 provides that, from March 1, income protection policy premiums will no longer be tax-deductible, while the benefits paid by these policies will be tax-free.
The change harmonises the tax treatment of policies that cover you for disability, death or severe illness, regardless of whether the benefit is paid as a lump sum or a monthly income. The premiums paid on policies that pay a lump sum in the event of death or disability are not tax-deductible, but the benefits are tax-free.
Until the amendment took effect, income protection policies were taxed differently.
If you took out an income protection policy in your name, until this month you could deduct your premiums from your taxable income at the end of the tax year. But you will not be able to claim this tax deduction at the end of the 2015/16 tax year in February next year.
If you belong to a group income protection policy scheme offered by your employer and your premiums are deducted from your salary, it is likely that have enjoyed a tax deduction. The withdrawal of this tax deduction will, from this month, result in an increase in your Pay As You Earn (PAYE) tax and a decrease in your take-home pay.
Employee benefits company NBC Holdings says an employee who pays a premium of R50 a month and who is on a marginal tax rate of 18 percent will see a reduction of R9 in his or her take-home pay.
Remember that the change to the marginal rates of tax, which were announced in the Budget, could also result in an increase in the tax you pay and a decrease in your monthly take-home pay at the end of March.
The change to the tax rates and to how income protection policies are taxed will not affect you if you earn below the tax threshold, which, for the 2015/16 tax year, is R73 650 a year for taxpayers under the age of 65.
If you are unable to work and have successfully claimed on an income protection policy, your income may increase, because the benefit will no longer be taxed. However, there will be no change if your income is below the tax threshold or if your life assurer limits the amount paid out to you to 75 percent of your after-tax income.
If your benefit will increase as a result of the switch to tax-free benefits, the extent of the increase will depend on your marginal tax rate: the more you earn and the higher your tax rate, the more you will get out, Rowan Burger, the executive for the large corporate segment at Momentum, says.
Using the 2014/15 tax rates, a person who earns R1 million a year, for example, and who is on a marginal rate of 40 percent, will see his or her benefit payout boosted by 48 percent. On the other hand, someone who earns R223 625 a year and who pays tax at 25 percent, will see his or her payout increase by 12 percent with the switch to tax-free benefits, Burger says.
Most South Africans are woefully underinsured for both death and disability, so the increase in the amount you could receive from an income protection policy could be a welcome boost to your finances.
Many individuals with stand-alone policies cannot afford the premiums, or do not commit enough financially to this cover, while many employees who belong to group income protection schemes are underinsured because of the way in which the benefit is calculated.
Brice Salence, the head of insurance pricing and reinsurance for group risk at Momentum Employee Benefits, says most employers that offer group disability cover base the contributions on pensionable salary – the salary on which your retirement fund contributions are based. If you receive cost-to-company remuneration, your pensionable salary is typically 80 percent of your cost-to-company salary.
Therefore, your disability benefit is typically calculated as 75 percent of your pensionable salary, or 75 percent of 80 percent of your cost-to-company salary. Salence says the result is that most employees end up with a disability benefit that is 60 percent of their cost-to-company salary, or an income replacement ratio of 60 percent. This is generally insufficient to meet the financial needs of a disabled claimant, she says.
Many people, particularly higher-income earners, should therefore benefit from the change in the tax status of any benefits paid from income protection policies, because the potential disability benefit will be more closely aligned to their current monthly income.