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Ways for providing tax efficient savings (Part 2)

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Tax efficient saving with insuranceBack in mid-1700’s Benjamin Franklin said, “In this world, nothing is certain but death and taxes”. Today, his words continue to echo in our realm of financial products where death and taxes have branched into life insurance and tax savings. In this article we shall look at the types of life insurance, their purpose, benefits, particularities and tax advantage.

The use of life insurance dates back from Roman times and nowadays is one of the most widespread methods of making tax-efficient saving while providing financial protection to those who we leave behind. The main purpose of life insurance is to give financial security to the beneficiaries in the event of the insured’s death or in the event the insured exceeds his financial resources.

The two basic types of life insurance policies available in Cyprus are: term and universal life insurance. Term insurance is the simplest form of life insurance, providing death coverage at fixed premiums for a fixed period of time. Universal life, on the other hand, offers death coverage as well as investment value upon maturity or surrender. In other words, a small part of the premiums paid for universal life will provide death benefit and the remainder will be invested, based on your choice, into predefined investment plans. Compared to universal life, term insurance is cheaper and also provides for higher death coverage; however, unless in the even of death, benefits will never be paid out. On the contrary, universal life is more expensive but offers the advantage of adjustable death benefits, investment of your premiums and pay-out upon application. Furthermore, the premiums are also flexible and you may take a short-term loan against percentage of the cash value.

Apart from requesting to read, understand and sign the universal life insurance contract in your language (if Greek is not the one), some issues of practical importance are: the cost your insurance will charge you and the frequency of your premiums. First of all, the whole or portions of your first premiums will be used to pay the insurance agent commission and administrative costs. Some people oversee this, since the cost does not stand out in the agreement and is often stated as a percentage of your premiums. Secondly, making monthly premium payments will result in higher transaction costs passed to you, compared to the transaction costs of quarterly, half-yearly or yearly premium payments. In addition to saving money by making less frequently payments, it will be less likely you are late or forget to make a payment, which may results in penalties or even insurance termination.

The main tax benefit associated with life insurance is that premiums are given tax deduction status, allowing you to reduce your taxable income and in effect pay less tax. While, premiums paid to either type of life insurance will reduce your taxable income, it is only the universal life, which serves as an investment.

The current Income Tax legislation in Cyprus allows tax deductible life insurance premiums only for up to 7% of the capital sum insured. So, if the capital sum insured is €70,000, the maximum premium that will be allowed is €4,900. In most cases your premiums will be below the limit determined by the law; however, this is not always the case. Furthermore, the tax law allows only premiums paid by and covering the life of the insured. Thus, premium payments made by a husband for the life insurance of his wife will not be allowed as his deduction. Finally, the sum of: social insurance, provident fund, medical fund, pension fund and life insurance premiums cannot exceed 1/6 (16.7%) of taxable income.

When deciding to surrender your universal life insurance before the 7th year since inception, you should consider that 30% of the premiums for which deduction was allowed will be added to your income (if the surrender is within 3 years from the date of the policy), or 20% of the premiums if the surrender takes place within 4th, 5th or 6th year. After the 6th year, if you surrender your life insurance, the value together with the investment return will be paid to you tax-free.

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