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02 February 2015 Neill Müller, Momentum Myriad & Katherine Barker, FundsAtWork

When comparing South Africa to the rest of the world, it is evident that the South African public faces some of the most taxes in the world. The public is taxed to the limit, and government has now introduced a shift in the way income protection policies will be taxed.

FAnews caught up with industry experts to find out what the change in the way income protection policies will be taxed, really mean for their clients.

Changes to the individual

Neill Müller, Head of Momentum Myriad Product Development, shares some insight into the changes individuals with income protection policies can expect.

What exactly will change in the law?

See the table below for all the changes.

How will individual clients currently paying contributions be affected?

Premiums paid in respect of income disability benefits were, up to now, tax deductible and insurers issued tax certificates for them.

For tax years commencing on or after 1 March 2015, the premiums paid in respect of income disability benefits will no longer be tax deductible and no tax certificates for premiums paid in respect of these benefits, after this date, will be issued.

How will individual clients be affected if they have claims in progress?

“Where monthly benefit payments are made to the policyholder following a successful claim, most insurers currently deduct the income tax before making the payment to the policyholder as these claim payments are fully taxable,” says Müller.

As from 1 March 2015, an income tax exemption will apply resulting in the monthly benefit payments being tax-free (provided all the requirements of the Income Tax Act no. 58 of 1962 are met).

If we look at the two scenarios, the public may find that they are in a better position post 1 March 2015 than they were before.

“I believe the best way to answer this is by way of an example. Let us say that a client is currently paying R1 000 per month for a monthly income protection benefit of R100,000 (and let us assume this represents 100% of the client’s pre-tax monthly income). Before the tax changes, the client would have been able to deduct the premiums paid from his or her annual taxable income. For some clients there was a real benefit in this annual tax deduction. After the tax changes, premiums will no longer be deductible from income taxes and this is applicable to all natural income protection policyholders,” says Müller.

From the above example, some clients may be tax neutral - where they reduced their benefit amount to reflect the after tax benefit at the subsequent lower premium - whereas others may find their take-home pay reduced as a result, where there is no change to their benefit amount and thus no change in premiums. The pre-tax change would have been better for the client in this instance.

It is important however, not to look at the premium impact in isolation. If a client had submitted a successful claim before the tax changes it would have meant that his or her R100 000 benefit would have been paid only after tax had been deducted. After the tax changes, clients who claim will no longer have tax deducted from their benefits before they are paid.

Therefore, although the client’s net take-home pay might be a bit smaller; he or she will receive a higher benefit once in claim. Even though these cases of over-insurance are found to be in the minority, in some instances clients could be in a situation where they will be over-insured post 1 March 2015. Should these clients claim, even though they can no longer deduct the premiums paid from income taxes, they may find themselves in a better position financially after the tax changes, than before the tax changes. As a result, the post-tax change would then be better for a client in this instance.

How will this affect the financial adviser?

Companies might limit the maximum benefit amounts they allow for new clients. The result of this will be lower premiums for clients, which could also lead to lower commission for financial advisers. This will however also provide advisers with an opportunity to ensure clients are adequately covered in areas where previous short-falls may have been.

Where clients decide to reduce their existing benefit amounts to the new, lower maximums after the tax changes, financial advisers may have commission clawed-back as is stipulated within the Long-Term Insurance Act, depending on the age of the policy.

Changes to group schemes

FAnews also caught up with Katherine Barker, Head of FundsAtWork Pricing, to look at the changes for those clients who belong to group schemes.

What exactly will change in the law?

How will this affect clients who belong to group schemes?

The employer will not be affected. The member will be affected as there will be no tax deduction on the premium that the member pays on a monthly basis. If the member becomes disabled and he or she starts to receive a monthly income disability benefit, he or she will not pay tax on the amount that he or she receives on a monthly basis.

How will this affect the company paying for their staff on the group scheme?

The company will not be affected as the employer will still get a tax deduction for premiums paid on behalf of the employee. Where the insurer pays the benefit to the employer for onward payment to the employee, the employer should not deduct any tax from the benefit from 1 March 2015. This also applies to employees who started receiving this benefit before 1 March 2015.

How will individual clients be affected if they have never claimed and there are no claims in progress?

These changes might have an effect on the take-home pay of members who are covered for disability income insurance benefits provided by their employers, as they will no longer be able to claim a tax deduction on the premiums.

How will this ultimately affect the financial adviser?

As members will not have to pay tax if they claim and they receive the benefit, there is some anticipation in the market that clients might reduce their insurance salaries. Hence, the premium that is paid will be less and therefore the financial adviser will receive less commission as the commission is based on the premium paid,” says Barker.

Momentum’s Financial Wellness Index indicates that South Africans are underinsured by an estimated 60% for life and disability cover. Employer sponsored benefits are often the only source of insurance cover that a person has. As most South Africans are underinsured, this tax change can be used to close the gap if they leave their insurance salaries as is and do not reduce it.

The examples show the impact on clients as discussed above:

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