Policy effects from recent tax changes

Myra Rego, FAnews Journalist

The growing desire from clients to have personalised insurance policies creates a significant opportunity for the industry to grow and prosper.

With the recent tax changes, financial planning will play an important role in ensuring that individual needs are met. Clients are subject to this change in tax treatment of income protection benefits and as such may find themselves in a better position financially after the tax changes, than before the tax changes.

Changes taking place

Worryingly however is that many clients are now cancelling cover in response to the pressure on household budgets, recent tax rises and the poor state of the economy. People are saying they can no longer afford cover but truth be told, an unforeseen circumstance may occur at any given time.

According to a recent Association for Savings and Investment South Africa (Asisa) study, South Africans are underinsured by about 60% for disability. Amendments to the Income Tax Act, will alter the tax treatment of income disability and contribute to closing the current disability insurance gap in South Africa.

Previously, income protection policy premiums were tax-deductible, but income at the claims stage was taxed. Following the amendment on March 1, premiums will no longer be tax-deductible and the proceeds of such policies will be tax-free.

Gareth Friedlander, Head of Research and Development at Discovery Life however pointed out that, “to be tax free, the amount must be in respect of a policy of insurance relating to the death, disablement, illness or unemployment of a person who is the policyholder or an employee of the policyholder in respect of that policy of insurance. This means that if the policy is not owned by the person who is insured, the payout will not be tax free (unless the recipient is an employee of the owner). This would have adverse tax consequences particularly for any trust owned income protection policies, where the payout was not tax free under the previous legislation,” he said. 

He further mentioned that clients who belong to group schemes are also subject to this change in tax treatment of income protection benefits and they will no longer be able to claim tax deductibility of the premiums they paid for this benefit.

“Payments to existing claimants will also no longer be subject to tax, provided they meet the requirements above. As a result, unless a company has specific policy conditions in place, they will now receive their gross income replacement sum assured as opposed to the net of tax figure,” he said.

Should these clients claim, even though they can no longer claim tax deductibility on the premiums paid, they may find themselves in a better position financially after the tax changes, than before the tax changes. 

The other side of the fence 

Friedlander pointed out that there is an impact for both existing and new clients. 

For new clients, insurers will implement new benefit maximums to ensure that clients are not over insured. This will see insurers move effectively to a net of tax income definition. 

For existing clients, insurers are likely to see a reduction in termination rates if clients do not adjust their cover appropriately. This is because if these clients were to claim they may end up receiving more for claiming (since payments are not taxed) than what they receive from their occupation (which is subject to income tax). As a result of this, insurers are likely to review their valuation assumptions which could result in companies holding larger reserves to meet this increased liability. 

“Clients who never claim (or claim infrequently) were better off under the previous tax treatment due to the fact that they were receiving a tax deduction of their premiums. For clients who claim frequently or for long periods of time, they will be better off under the new structure. It is however, important to note that it is certain that policyholders will pay premiums, and would have enjoyed the tax deductibility of premiums, however a relatively small percentage of clients will actually claim and benefit from tax free payments,” said Friedlander.

A learning curve

Advisers will have an opportunity to ensure clients are adequately covered in areas where previous short-falls may have existed and are encouraged to ensure that they fully understand their clients’ tax situations to have the correct amounts of income replacement covers in place. 

On the other hand, most insurers have already revisited their offerings to take the tax changes into consideration to adjust benefits and definitions appropriately. 

Editor’s Thoughts:
With these tax changes, clients need to be informed to make sound financial decisions. This is where financial advisers play important roles to ensure clients are adequately covered. Please comment below, interact with us on Twitter at @fanews_online or email me your thoughts [email protected]

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