Investment vs. risk life insurance

This article was co-written by Monika Souza, a financial advisor belonging to our family of expat-friendly services in Brno.

Dear Brno Expat Centre friends, lots of you were asking me how to tax your life insurance and where to find documents for your employer in order to apply for the tax relief. Please take a minute to read this article that can help you understand whether your life insurance is tax-deductible, and what the pros and cons of each specific type of life insurance are.

Let’s have a closer look at life insurance and the options you have on the Czech market.

1) Investment life insurance

The first type I want to talk about is investment life insurance. It consists of two components – premium and investment. The insurance component should prevail so that life insurance serves primarily as insurance protection. Within the investment component, investments are made in mutual funds.

Your employer can also contribute to your investment life insurance, which is a popular option, because it can be deducted from the tax base. For the entire calendar year 2021, a maximum of 24,000 CZK can be deducted from the tax base. It is also a maximum that cannot be exceeded, even if you have more than one life insurance policy. Premiums will be added, but up to a maximum of 24,000 CZK. However, this maximum amount will reduce the final tax to be paid by only 3,600 CZK.

There are certain criteria that your insurance contract must meet in order to be tax-deductible. 

• The contract must be concluded for a minimum of 60 months (5 years) duration.
• The contract must last at least until the age of 60.
• Only coverage of death and the investment component are tax-deductible. The other supplementary insurances are not tax-deductible.
• The policyholder and the insured are the same person.

In case of early termination of the investment life insurance contract and in case you have applied the tax benefits on the contract, you will be obliged to return the amounts from the reduced tax base for the last 10 years. The amounts must be taxed according to the law as other income. The value of the investment will not be paid back to you entirely – the insurance company will withdraw its costs and fees (monthly and annual fees, management fees, administration fees ) before sending you the remaining value. On top of that, you are obliged to pay 15% tax on profits from the investment component.

Investment life insurance may be suitable for young people in their 20s, as it might be cheaper than a risk life insurance. However, early termination is almost always disadvantageous, as the insurance company charges many fees.

2) Risk life insurance

The second option is a risk life insurance. It only covers risks and does not contain an investment component. Your entire payment is used to cover the insured risks. If you are young, the risk life insurance may be slightly more expensive for you. However, for most clients, it is more beneficial as the cancellation policy is simple and quite straightforward. When arranging risk life insurance, it is important to set the insured sums correctly. Before choosing an insurance policy, it is good to consider the individual financial situation – calculate the income, expenses, what financial reserve you can count on, and choose the insurance amounts accordingly. 

Most insurance companies also offer insurance with a so-called linearly decreasing sum, because your regular expenses may change over the years – for example, you no longer have to support children or gradually repay part of your mortgage or loan. The price of the premium depends on the sum insured. Because, unlike investment life insurance, risk life insurance does not include an investment component, the premium is often lower.

In addition to the sum insured, the price of the premium is also affected by:  

• employment – the riskier your job, the higher the premium you pay
• age – higher age means a higher risk of illness or death, therefore higher premiums
• health condition – your health condition is examined by the insurance company before the insurance policy is concluded
  

Compared to investment life insurance, the policy is much simpler. In case of early termination, you don’t get any money back. The termination period is often two to three months, depending on each insurance company’s policy. You can cancel the newly concluded insurance within 2 months with an 8-day notice period. If you stop paying the insurance, the contract will not end immediately – this will happen only after further notifications from the insurance company. However, the institution will recover the debt and can add penalties to it, so it is always better to choose the official path of a termination letter.

This product is suitable for those who want to secure their loved ones in the event of death and can be recommended to secure a mortgage or other loans.

My personal recommendation?

As a financial expert, I advise separating life insurance and investment. In mutual funds, you are charged lower fees compared to investment life insurance and profits are free of 15% income tax (after 3y. of being invested). You can have better control over your investment and reach better results. It is more effective. Life insurance is a must for most of us – especially for families with children, clients with mortgages and loans (debts are inherited), and all the people without millions of CZK in their bank accounts ☺. 

However, don’t conclude life insurance without a proper and deep analysis of your needs!

The clerks at your bank may not have all the professional knowledge and you may be offered insurance as a product (typically free life insurance with a credit card or mortgage loan). Always consult a specialist who can help you calculate the appropriate insurance protection based on your specific needs and your life situation, give you an explanation of what you’re going to pay for, why, what the pros and cons of that specific contract are. And more importantly, a specialist will help you (or your family) deal with the correct documents in case an insurance event needs to be claimed.