It is likely that holders of income protection policies will be able to claim their premiums as a tax deduction for one more tax year, after National Treasury told Parliament’s standing committee on finance this week that it will propose that an amendment to scrap the deduction becomes effective only from March 2015.
The amendment to the Income Tax Act will remove the tax deduction for premiums but will make tax-free the monthly income you receive from an income protection policy. The amendment is contained in the draft Taxation Laws Amendment Bill, which the standing committee on finance discussed this week.
The bill proposes that the amendment is implemented on March 1 next year. But, in submissions on the bill, life assurance companies and employers suggested the amendment is scrapped, or at least postponed, so that they can renegotiate their income protection policies with employees and policyholders. It was unlikely that these negotiations would be concluded by March 1, 2014, they said.
This week, in response to the submissions, Beatrie Gouws, Treasury’s director of personal income tax and savings, said Treasury partially accepts the arguments of the life assurers and employers, and will push out the implementation date by a year.
The amendment, which was announced by Finance Minister Pravin Gordhan in the Budget this year, will standardise the tax treatment of personal life assurance policies that offer protection against death, disability, severe illness and unemployment.
Currently, if you take out a life assurance policy that will pay out a lump sum on disability, your premiums are not tax-deductible, and if your claim against the policy is accepted, the lump sum is paid tax-free. On the other hand, the premiums on income protection policies, which also offer protection against disability, are tax-deductible, and the monthly income is taxed at your marginal rate of income tax.
In addition, the Association for Savings & Investment SA says the South African Revenue Service treats the monthly income paid from income protection policies inconsistently. In some cases, policyholders who did not enjoy a tax deduction on their premiums are also being taxed on the annuity payouts from these policies.
The amendment will ensure consistency in the tax treatment of premiums and benefit payments, and will also result in policyholders who receive monthly payouts temporarily not paying tax on that income.
Once the amendment has been implemented, you, as the holder of an income protection policy, should check on the monthly amount you can claim for disability, because, currently, the amount for which you are insured is based on providing you with a pre-tax income, rather than the tax-free income you will require after the change is implemented. This means that, once the amendment takes effect, you may be able to insure yourself for a lower amount, because you will no longer have to take into account the tax on your monthly payout.
You must make sure that you are not overinsured. Generally, life assurers will pay out an income that is, at most, 75 percent of what you were earning before you were disabled. This removes the incentive for opportunistic claims on income protection policies. Some policies have an exception to the 75-percent limit, either for temporary disability or for disabilities from which you will never recover.
Life assurance companies say they will have to contact all their policyholders to inform them of the change and find out whether their policyholders want to adjust the income for which they are insured, to ensure they are not overinsured.
In their comments on the bill, life assurers also pointed out that disabled people who are claiming on their policies will receive an increase in their monthly income after the amendment is implemented, because tax will no longer be deducted.
They said some people who are claiming do return to work, but the higher payouts will disincentivise them from doing so, and this will result in a “significant” cost to the industry. Treasury rejected this argument, saying that life assurers must ensure they pay out only legitimate claims.
Treasury also rejected an argument that the amendment will significantly reduce the take-home pay of policyholders who currently claim their premiums as a tax deduction. It said that policyholders will be able to reduce their monthly premiums, because, as a result of the tax-free status of the payout, they will require lower benefits.
National Treasury undertook to investigate a recommendation that retirement funds be allowed to provide an income to their members who are disabled temporarily.
The proposed amendment will be introduced “cleanly going forward”, the explanatory memorandum to the draft bill, which was published in July, states. In other words, although you may have enjoyed a tax deduction on your premiums for years, from the date on which the amendment takes effect, all payouts from income protection policies will be totally tax-free and not partly taxed and partly not taxed in line with the number of years the policy was held before and after the amendment.