Until 2010, Australian tax residents with offshore investments were generally required to declare, and pay tax, on these investments on an annual basis. This was covered by the Foreign Investment Fund (FIF) rules. However, in 2010 these rules were repealed and replaced with the Foreign Accumulation Fund (FAF) rules.

The FAF rules dramatically changed the scope of which offshore investments were subject to taxation when an Australian returned home. One of the most important changes introduced is that foreign life insurance policies are now treated the same as domestic life insurance. This means that they are not reportable or taxed on an annual basis.

This opens the door to a powerful financial planning tool for Australian expatriates. Foreign life insurance investments generally have a wider investment choice than their domestic counterparts. This greater choice offers the chance for better growth and better financial planning.

 

Why use life insurance as an investment vehicle?

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Outside of the traditional form of life insurance, whereby a policyholder pays a premium to be covered for a large amount of money in the event of their death, there are various investment platforms offered by life insurance companies.

It is very common to use life insurance as an investment platform because it provides some useful financial planning benefits.

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Capital Accumulation – Gross Roll Up

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International life insurance products are generally not subject to tax while the investments accumulate in value. This means your savings can grow free of tax, with the exception of certain withholding taxes.

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Switching Funds

As your investments grow, you may wish to switch funds to realise gains and invest in new opportunities. Buying and selling funds directly can create a liability to taxation on gains, but by using life assurance products, you should be able to avoid this and make decisions driven by investment performance rather than tax considerations.

International life insurance also offers investors the following advantages:

• The potential for tax-free withdrawals later in life (more on this below)

• Benefits can be paid to spouses and next of kin free from taxation

• A wide investment choice which can include almost any tradable asset in the world

• Multiple currency options

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From year 11 onwards any withdrawals taken from the life insurance investment are not subject to any taxation.

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Tax-free withdrawals from life insurance policies

A day will come when you will want to withdraw money from your investments to supplement your income, during your retirement for instance.

For the first 8 years of a life insurance investment, Australian tax residents can be subject to taxation on withdrawals they make at their marginal rate:

• 0 – 18,200 AUD = 0%

• 18,201 – 37,000 AUD = 19%

• 37,001 – 80,000 AUD = 32.5%

• 80,001 – 180,000 AUD = 37%

• 180,001+ AUD = 47%

 

At this point there is no real benefit to having a life insurance investment over any other kind of investment. However, from year 9 onwards the story becomes more interesting.

In year 9, only two-thirds of the gains are taxable at your marginal rate. In year 10, only one-third of the gain is taxable. Finally, from year 11 onwards any withdrawals taken from the life insurance investment are not subject to any taxation.

There are, of course, careful rules that you must comply with in order to receive this benefit and we suggest you always seek professional help from a financial advisor. You should be aware that it is not possible to add significantly large sums to an existing investment and still avoid a possible tax charge after ten years. Rules exist that are designed to restart the ten-year period from the start of the policy year in which the new investment is made.

Nevertheless, for anyone who has long-term financial planning goals, which we all should have, this is a very powerful way of creating a tax-free income later in life.

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How to calculate the taxation of life insurance

In accordance with Section 26AH (6) ITAA 1936, the owner of an international life insurance policy will be assessed for income tax on chargeable bonuses.

To calculate the amount of bonus assessable for income tax the following formula is used:

Relevant amount (bonus) = (A/B) * [(B+C) – (D+E)]

A = the amount withdrawn from the policy

B = surrender value immediately prior to the withdrawal sum of any

C = earlier amounts paid out

D = total gross premiums before charges paid to the date of withdrawal

E = sum of any previous relevant amounts
(chargeable profits)

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An example…

Initial Investment = 100,000 AUD

Surrender Value at time of withdrawal = 150,000 AUD

25,000 AUD Withdrawal in Year 8

Relevant amount = (25,000/150,000)*[(150,000 + 0) – (100,000 + 0)] = 8,333 AUD

25,000 AUD Withdrawal in Year 9

Of the 8,333 AUD calculated above only two-thirds is assessable = 5,555 AUD

25,000 AUD Withdrawal in Year 10

Of the 8,333 AUD calculated above only one-third is assessable = 2,777 AUD

Year 11 onwards

Any amount received as bonus will not be assessable for income tax.

As you can see from this simple example, the use of life insurance based investments can offer Australian’s some significant long-term tax benefits. It is therefore, a very worthwhile tool to consider for your financial planning needs such as retirement.

For more information on this topic contact us using the form below.

Disclaimer: This article represents our opinion on the current tax regulations in Australia at the time of writing and should only be used as a guide. Always speak to a financial advisor before making any decisions.