Tax on Insurance Payouts, Prizes and Windfalls

Working through the common cases

The insurance row is the one that resists a simple answer, and the reason is worth understanding rather than memorising.

The insurance principle

Insurance payouts follow what tax people call the replacement principle: a payout generally takes on the character of whatever it replaces.

This is why two people can receive the same dollar amount from the same insurer and face different tax outcomes. The label on the policy matters less than what the payment is compensating for. Where a policy pays out on a mix of grounds, the components can be treated differently, and that is a point to raise with an accountant rather than assume.

The part that is always taxable

Whatever the source, once the money is yours, what it earns is ordinary taxable income. This is where a tax-free windfall quietly becomes a tax obligation.

Two practical consequences follow. First, resident withholding tax will be deducted from that interest, and if your RWT rate is set too low you will owe the difference at the end of the year. Second, a person who has never filed a return may suddenly need to think about one, particularly if income arrives from several sources.

Getting the withholding rate right is the easiest win available here. The RWT and PIR guide covers how to choose it, and choosing a PIE structure instead can cap the rate at 28% for someone who would otherwise be on 33% or 39%.

It can also change what you receive

A windfall is not income, but the income it produces counts for the tests that decide entitlements. Working for Families, student allowances, the Community Services Card and student loan repayment obligations all look at income. A large sum sitting in the bank can also count as an asset for means-tested support.

None of this makes receiving the money a bad thing. It does mean the first sensible step after a windfall is to work out what changes, rather than to make a decision about it quickly.

Gifting: no duty, but not consequence-free

Gift duty was abolished for dispositions made on or after 1 October 2011, so you can give money away in New Zealand without a duty charge. That fact is widely known and widely over-read.

Gifting still matters in at least three places. It is considered when the Ministry of Social Development assesses eligibility for the residential care subsidy, where gifts made above certain limits and within certain periods can be counted back into the assessment. It can be relevant to relationship property, because gifted money may or may not stay separate property depending on how it is handled. And where a gift is really payment for something, it is not a gift at all and can be assessable income.

What to do in the first month

What this guide does not cover

Foreign inheritances and payouts from overseas can raise foreign investment fund rules, foreign superannuation rules and double tax questions that are genuinely complex. Payouts under employment settlements have their own treatment. Compensation for land acquisition, leaky building claims and earthquake settlements each have specific rules. This is general information rather than tax advice, and any large or unusual payout is worth an hour of an accountant's time before you spend any of it.

Test Your Knowledge

Ten questions on what is taxed when money arrives unexpectedly.

Sources: Inland Revenue on taxing prize money, types of individual income and other income, and Inland Revenue Tax Technical on gifting and on when gifts are assessable income. Insurance payout treatment depends on what the payment replaces and is worth confirming with an accountant.