Worked Examples and Checklists
Tax on life insurance and TPD payouts in Australia, worked out
How death benefits, TPD lump sums, trauma and income protection benefits are taxed, inside and outside super, with worked examples for dependants and adult children.
Life cover, TPD and trauma paid under a retail policy you own are generally not taxed. Income protection benefits are taxed as income, wherever the policy is held. The big differences are inside super: a death benefit paid to a tax dependant, such as a spouse or child under 18, is tax-free, but paid to a non-dependant, such as an adult child, the taxable component is taxed at up to 15% plus Medicare levy (taxed element) or 30% plus Medicare levy (untaxed element, which often includes insurance proceeds). A TPD benefit from super is taxed at up to 20% plus Medicare levy on the taxable component if you are under 60, and is tax-free from 60.
This guide is part of the worked examples section. Amounts are illustrative. Tax law is complex; check the ATO and get advice for real estates and claims.
Summary table
| Payout | Outside super | Inside super |
|---|---|---|
| Death benefit to a tax dependant | Generally tax-free | Tax-free as a lump sum |
| Death benefit to a non-dependant (e.g. adult child) | Generally tax-free | Taxable component taxed: taxed element up to 15% + Medicare levy, untaxed element up to 30% + Medicare levy |
| Terminal illness benefit | Generally tax-free | Tax-free if the terminal medical condition requirements are met |
| TPD lump sum | Generally tax-free | Disability super benefit: tax-free component increased for future service; taxable component taxed at up to 20% + Medicare levy if under 60, tax-free from 60 |
| Trauma | Generally tax-free | Not available in super |
| Income protection | Taxable as income | Taxable as income |
Who is a dependant for tax purposes?
For super death benefits, a death benefits dependant includes a spouse or former spouse (including de facto), a child under 18, someone financially dependent on the deceased, and someone in an interdependency relationship. Adult children are dependants only if they were financially dependent or in an interdependency relationship. This is a tax definition. Who can receive the benefit at all is set by super law and the fund's rules.
What are the taxed and untaxed elements?
Most of a super balance is the taxable component, taxed element, because contributions tax has already been paid. When a fund pays a death benefit that includes life insurance proceeds and the fund has claimed a deduction for the premiums, part of the taxable component may become an untaxed element, taxed at up to 30% plus Medicare levy for non-dependants. The fund calculates the split.
Worked example 1: death benefit to adult children
Illustrative: Helen, 64, a widow, dies with a super balance of $180,000 and $250,000 of death cover in super. Her two adult children, who are financially independent, are the nominated beneficiaries. The total death benefit is $430,000.
Suppose the fund calculates:
- Tax-free component: $30,000.
- Taxable component, taxed element: $150,000.
- Taxable component, untaxed element (from the insurance): $250,000.
Tax:
- Taxed element: $150,000 × 17% (15% + 2% Medicare levy) = $25,500.
- Untaxed element: $250,000 × 32% (30% + 2%) = $80,000.
- Total tax ≈ $105,500, leaving about $324,500 for the children.
If Helen had held $250,000 of life cover outside super with her children as beneficiaries, that $250,000 would generally have been received tax-free. Even after paying retail premiums from her own money, for her the after-tax difference was large. Where adult children are the likely beneficiaries, consider holding life cover outside super, or ask an adviser about strategies within the rules.
If the death benefit is paid to the estate, tax is worked out by reference to whether the beneficiaries of the estate are dependants, and the estate's executor handles it.
Worked example 2: TPD from super at age 48
Illustrative: Marco, 48, receives a $300,000 TPD benefit paid to his super account, then withdraws $300,000 as a disability super benefit. His other balance is left in the account.
For a disability super benefit, the tax-free component is increased by an amount based on the days from leaving work to age 65, relative to total service. Suppose the fund calculates the tax-free component of the withdrawal as $120,000 and the taxable component as $180,000 (taxed element).
- Marco is under 60 (preservation age), so the taxable component is taxed at up to 20% + Medicare levy = 22%.
- $180,000 × 22% = $39,600.
- He receives about $260,400.
At 60 or over, the same withdrawal would generally be tax-free. Tax is withheld by the fund and reconciled in his tax return; he may get a tax offset that reduces the rate. Build this into how much TPD you hold in super, see how much TPD cover do I need.
Worked example 3: income protection
Illustrative: Kate receives $4,500 a month for eight months from a retail policy, $36,000 in total, and earned $40,000 of salary earlier in the year. Her taxable income is $76,000, so her top dollars fall in the 30% bracket. Tax is worked out on her total income for the year, not on the benefits separately, and the 2% Medicare levy applies on top. If the insurer withheld tax, she claims a credit in her return. The premium was deductible; see the tax deduction guide.
Practical points
- Nominations. Super death benefits follow the fund's rules and your nomination. A binding nomination, where allowed, must be valid and current; many lapse after three years unless non-lapsing.
- Estate planning. Paying a death benefit through the estate lets your will direct it, but can expose it to claims on the estate.
- Re-contribution strategies and other planning to reduce taxable components exist but depend on your age and circumstances. Get licensed advice.
- Retail ownership. A policy owned by you on your own life, with a nominated beneficiary, pays outside your estate and outside super tax rules.
See also cover inside super versus retail.
Frequently asked questions
Is a terminal illness payout from super taxed?
Not if you meet the terminal medical condition requirements, generally two registered medical practitioners, including a specialist, certifying that the illness is likely to result in death within 24 months.
Is a death benefit pension taxed?
Death benefit income streams are taxed differently. They can only be paid to certain dependants. Tax depends on the ages of the deceased and the recipient.
Does capital gains tax apply to a life insurance payout?
Generally not for the original beneficiary or policy owner of a policy on their own life. Policies bought from someone else can be different; ask a tax adviser.
Sources
- ATO — super death benefits, disability super benefits, terminal medical conditions
- Moneysmart — nominating super beneficiaries
- Federal Register of Legislation — Income Tax Assessment Act 1997
