Employees face more tax on Group Life cover, Income Protection and other employee risk benefits
13 December 2011
Posted by: SAIT Technical
You face paying more tax on employee risk benefits
Business Report - Laura du Preez
Changes to the Income Tax Act that take effect from March next year could again have repercussions for you, as an employee, if your employer pays for your group life cover, income protection cover or funeral policies in what is known as an unapproved group risk bene-fit scheme.
The changes could affect the amount of tax you pay or could see your employer restructuring your assurance benefits. Amendments to the Income Tax Act that change how these policies are taxed were introduced in March this year, but the changes had some unintended consequences.
As a result, the Taxation Laws Amendment Bill, which has passed through Parliament and is expected to be promulgated before the end of this year, effectively repeals the changes made last year and introduces new ones as of March 1 next year. Hugh Hacking, the head of retirement fund solutions at Old Mutual Corporate, says that if the tax changes affect you, the increased tax you will pay is likely to be small relative to your current tax liability, unless you are a high-income earner.
Employers will probably need to take tax advice to ensure that they have structured your assurance benefits correctly, and some may use the opportunity to restructure your benefits, Hacking says. If that is the case, you may need some advice to ensure that you are not left worse off. The changes should not affect you if you and your employer contribute to your retirement fund and if your fund pays the premiums for a group life policy on behalf of the members (an approved group risk benefit scheme – see "Types of benefits your employer may offer”, right).
However, if your employer pays the premiums on a group life policy directly to an insurer on your behalf, this is known as an unapproved group risk benefit scheme. If your employer pays the premiums on your behalf as an employee benefit – that is, without reducing your salary in any way – and you are not already being taxed on this benefit, it will become a taxable fringe benefit on March 1 next year, when the latest changes to the Income Tax Act become effective.
The changes could affect the tax you pay in one of three ways:
1. Fringe benefits tax on premiums paid
Last year’s changes to the tax laws were aimed at ensuring that when your employer pays the premiums on your behalf to an unapproved group scheme for life assurance, lump-sum disability benefits or funeral benefits or for an income protection policy, this would give rise to a taxable benefit. However, the explanatory memorandum to the Taxation Laws Amendment Bill 2011 says the language used in the changes was not explicit enough, and some employers took the position that the premiums they paid to a group life scheme did not give rise to a taxable benefit for an employee. Hein Daffue, Sanlam’s legal adviser, says the South African Revenue Service argues that despite the inadequacy of last year’s changes, which took effect this year, premiums paid by an employer are in any case a taxable benefit under the definition of "gross income” in the Income Tax Act. But he says some tax specialists do not agree that the employer-paid premium falls under this definition. The changes to the Income Tax Act that will become effective on March 1 next year are aimed at making it clear that if your employer pays premiums for a policy that may benefit you or your beneficiaries, the premiums will be added to your income as a taxable fringe benefit. If your employer pays one recurring premium for such cover for all its employees, your employer will be expected to divide that premium by the number of employees, and the result will be the amount of your taxable fringe benefit.
2. Tax deductions for premiums
If you pay your own premiums for an income protection policy, you are entitled to deduct the premiums from your taxable income. If your employer pays the premiums for an income protection policy on your behalf, this is deemed to be a taxable fringe benefit, but the premiums will be tax deductible for you after March 1 next year. This means the fringe benefit that is added to your taxable income will be offset by the deduction allowed against your income. You do not qualify for a deduction on the premiums that become taxable from March next year if your employer pays to a group scheme offering life and lump-sum disability benefits.
3. Exemptions from tax for the proceeds
The changes to the Income Tax Act that will be introduced next year are designed to ensure that if you contribute to an assurance policy using after-tax income and without a tax deduction, the proceeds of the policy paid to you or your dependants will be tax-free. However, if your premiums were funded with before-tax contributions or with a tax deduction, the policy proceeds will be taxable. This means that where your contributions to an income protection policy are tax deductible, the proceeds – the monthly income you receive if you are disabled – will be taxable. If your employer pays contributions to an unapproved group life scheme as a benefit for you, it was unclear after last year’s changes whether or not the proceeds of the group life policy – when and if they were paid to you – would be tax-free. The changes to the Income Tax Act that take effect on March 1 make it clear that if your employer pays the policy premiums and you pay fringe benefits tax on these premiums, the proceeds will be tax-free. Daffue says where the proceeds of a policy are paid out first to an employer and then to the employee’s beneficiaries or deceased estate before March 1 next year, the proceeds will in all likelihood be taxed in the hands of the deceased’s estate. However, he says, if the policy provided for a payment directly to a deceased employee’s estate or beneficiaries, the proceeds would be tax-free.
Types of benefits your employer may offer
Employers typically offer you life and disability benefits obtained at favourable group rates in order to sweeten your employment contract. These benefits may be structured in a number of ways, and your employer may offer a variety of structures without you, as an employee, being aware of this, Hugh Hacking, the head of retirement fund solutions at Old Mutual Corporate, says. Hacking says employers who contribute to an umbrella retirement fund (a fund in which multiple employers participate) likewise use a variety of group life structures:
* Approved scheme: group life, lump-sum disability and/or funeral cover within your retirement fund
You and your employer contribute to the fund. The fund may use a portion of the contributions to pay premiums for group life cover, lump-sum disability and funeral cover for the members of the fund. These are known as "approved” group risk benefit schemes. If you die or are disabled before retirement, the fund will receive the policy proceeds. In the case of disability, the disability benefit is paid to you. In the case of death, the proceeds and the fund credit are paid to your dependants, as decided by the trustees of the fund. Lump sums paid to you from the fund are taxed in your hands according to the retirement fund lump-sum tax table. This provides for a once-off tax-free amount of R315 000 on retirement or death; thereafter, set tax rates apply, which depend on the amounts received.
* Unapproved scheme: group life, disability, income protection and/or funeral cover directly from an insurer, paid for by your employer
Your employer may pay premiums directly to an insurer for lump-sum disability cover and/or income protection cover for its employees, group life cover and/or funeral cover for its employees’ families. These policies are known as "unapproved” group risk benefit schemes. Income protection policies are designed to pay you a monthly income to replace the income you lose on becoming disabled and unable to work. Income protection policies differ from |lump-sum disability policies that pay you a lump sum should you become disabled.
If you are disabled before retirement, your employer may receive the policy proceeds and pay them over to you. If you have nominated your beneficiaries to receive the benefits on your death and you die before retirement, the benefits may then be paid directly to your beneficiaries. Your employer may pay the premiums on your behalf as a benefit on top of your salary or simply offer you the opportunity to participate in such a group scheme but expect you to pay the premiums from your after-tax salary, in which case the premiums will reduce your salary. Where you have paid the premiums from your after-tax salary, the proceeds of the policies will generally be paid to you tax-free.
The exception is premiums paid for an income protection policy, because you enjoy a tax deduction for these premiums. Therefore, the monthly income paid to you will be taxable. Where your employer pays the premiums as an additional benefit for you, you may be liable for a taxable fringe benefit. If the policy is not an income protection one, when the lump-sum proceeds are paid to you, these will generally be tax-free.
However, if the policy pays out to your employer and your employer uses the proceeds, for example, to pay you a salary when |you become disabled, the salary paid will be taxed.