Income protection: Treasury seeks harmony
You could soon lose any tax deductions you enjoy for contributions to an income protection policy if a proposal outlined in the Budget Review is adopted.
The Budget Review says government proposes to introduce consistency in the tax treatment of all non-retirement fund disability and income protection policies by denying tax deductions for contributions but allowing payouts to be made tax-free.
Currently, some income protection policyholders enjoy tax deductions while others do not.
Policyholders with tax deductible policies expect, in the event of a claim, to be taxed on their monthly income from the policy, while those with policies that are not tax deductible expect the payout to be tax-free. However, this is not always the case.
The proposal to introduce a consistent tax approach could have broad implications for your financial planning if you have a deductible income protection policy, affecting the tax you will pay once the deduction is withdrawn and the amount of income protection cover you need.
Liberty says if the proposal is implemented, existing policies would have to be reviewed to ensure they provide for an income net of tax and not gross of tax, or you could find yourself over-insured. It says policyholders would “arguably be worse off financially as a consequence of the change”.
In particular, Liberty says, it would be unfortunate for self-employed individuals if the current tax deductions on much-needed risk protection for business purposes were to fall away.
Peter Dempsey, deputy chief executive officer of the Association for Savings & Investment SA (Asisa), says income protection policies were originally sold to self-employed people, and the expense of the premium was considered an expense in the production of income.
But these policies are now also sold to salaried employees and are treated differently by South African Revenue Service (SARS) offices around the country.
Some SARS offices are not allowing taxpayers to deduct their income protection policy premiums from taxable income on the grounds that, for a salaried person, the premiums are not an expense in the production of income, he says.
Those who claim on their policies find some SARS offices are treating the monthly payments as annuities and are taxing them, which is a problem for those who were denied a deduction on the premiums, Dempsey says.
He says Asisa has been engaging with SARS and asking for a ruling on income protection policies one way or another so that taxpayers have certainty.
Dempsey says Treasury’s view is that premiums on all private insurance policies that pay out on the occurrence of an event should not be tax deductible, but the pay outs should be tax-free.
The Budget Review says many current policies blur the distinction between whether they compensate for the loss of income – which is tax deductible – or compensate for loss of personal capital, such as the loss of an arm, which is not tax deductible.
Harry Joffe, the head of legal services at Discovery Life, says policies that include sickness benefits as well as income protection have also been creating problems for SARS.
Keith Engel, Treasury’s chief director of tax policy, says that in addition to bringing in a consistent tax treatment of insurance policies, doing away with the deduction for income replacement policies will make it easier for you to complete your tax return through eFiling.
Dempsey says the issue is broader than just income replacement as it also affects “key man” policies used by businesses to insure against the loss they would face if a key person in the business died or was disabled.
Liberty says the tax deductibility of contributions is a key attraction of income replacement policies, and the policies would be less appealing to consumers should the tax change go ahead.
The change could lead to more consumers opting for lump-sum disability policies instead of income protection policies, or even deciding against buying income protection cover. This could potentially increase the income protection insurance gap in South Africa, Liberty says.
Dempsey says that, while Asisa believes the principle of treating all private insurance as non-deductible but exempt on payout is good, it will engage with Treasury on the detail, be-cause some transitional arrangements may have to be made.
For example, he says, stressing that he is speculating in the absence of concrete details, it may be decided that payouts from existing income protection policies will be partly taxed and partly tax-free in line with the period for which you did and did not enjoy a tax deduction on your premiums.
Joffe says income and sickness protection are an important benefit for self-employed people and it may make sense for the government to consider allowing only self-employed people to deduct their premiums on these policies, because in their case they fulfil a genuine business need.
Liberty says if the proposed changes are applied to existing policies, the income definitions, cover amounts and terms and conditions of these policies may need to be adjusted, because they were designed for the existing tax regime. This may prove extremely challenging, it says.
Liberty expects there will be extensive consultation before any changes are implemented.
It also says that if the change is implemented, product providers will explore opportunities to include income protection options in retirement annuities and other retirement products.
REMEMBER: Even if you lose the tax deduction for premiums on income protection policies in future, these policies may enable you to match your cover to your income needs after disability much more closely than you can with a lump sum. They may also offer protection against temporary disability, while lump-sum disability policies only pay out on permanent disability.