Key types of insurance available via super
Three types of insurance are usually available within a superfund, including an SMSF. A member can generally purchase the following types of insurance via a super Fund:
- Life Insurance
- Total and Permanent Disability (TPD) Insurance; and
- Income Protection Insurance.
There are a number of issues to consider when insuring via the super environment:
The sole purpose test
A SMSF must be maintained solely for at least one or more core purposes and (optionally) for one or more ancillary purposes.
A core purpose is to provide for:
- member upon retirement
- a member upon reaching age 65’s dependants in event of death.
Purchasing life insurance on behalf of a member would typically satisfy the sole purpose test.
An ancillary purpose is to provide for:
- a member’s temporary or permanent cessation of work as a result of physical or mental ill-health.
Purchasing Income Protection (or salary continuance) and Total and Permanent Disability Insurance on behalf of a member would typically satisfy the sole purpose test.
Tax effectiveness of insurance held through SMSFs
Life insurance premiums payable by the SMSF are generally tax deductible to the fund. Life and TPD premiums on policies held outside of super are not.
The actual payment of insurance premiums by the SMSF can also be tax-effectively funded by using super contributions, as employers can claim a tax deduction for all super contributions (Superannuation Guarantee and Salary Sacrifice).
Potential limitations on accessibility of benefits
As the policy(s) will be owned by the SMSF, proceeds will first be paid to the fund. Payment can only be made to the member once a condition of release has been met. In the case of death or temporary incapacity, this should occur quickly and simply.
Some flexibility and/or the availability of certain options may be reduced as a result of purchasing insurance via a super fund.
Death benefits may only be paid directly to a super dependant or legal personal representative.
Taxation of the benefit on payment
The tax treatment of a benefit payment will depend on:
- the type/cause of the payment being made (death, TPD, salary continuance)
- how it is paid (lump sum or income stream); and
- to whom the benefit is paid (member, dependant or non-dependant).
Life Insurance is typically purchased when a person wishes to provide their dependants with financial security in the event of the person’s death. Special consideration should be given to whether the payment is to be made to a dependant or non- dependent and the tax implications of this benefit.
Payment to a dependant:
Irrespective of whether the Fund has claimed a tax deduction, the payment as a lump sum to a tax dependant will always be tax free.
Where the death benefit is paid as a pension, the tax treatment of the income stream will depend on the age of the deceased and/or the recipient:
- provided at least one is aged 60 or over, pension income will be received tax free; otherwise
- the taxable portion of income stream payments will be taxed at the beneficiary’s marginal tax rate less a 15% tax offset.
Acquisition of a Life Insurance Policy by an SMSF
Generally SMSFs cannot acquire an existing Life Insurance Policy from a member or a member’s relative. As such, in order to transfer any existing cover into their SMSF, a member may need to apply for a new policy to be issued and may also need to go through the underwriting process again. This could present an issue where a member’s health has deteriorated since first taking out the policy.
However, some life insurance companies have existing processes in place to allow a new (or effectively a replacement) policy to be issued in the name of the fund without the need for additional underwriting. This generally makes transferring existing cover into a fund a much less daunting prospect.
Total and Permanent Disability (TPD) Insurance
TPD Insurance is usually insurance that is attached to a Life Insurance Policy, with the benefits being released to the Fund (as the policy owner) once the member meets the policy’s total and permanent disability definition. In order for the Fund to then release the proceeds to the member, the member will also need to satisfy a SIS condition of release.
Due to the nature of the SIS condition of release that relates to permanent incapacity, an ‘own occupation’ definition TPD Policy held through an SMSF may create a situation where insurance benefits are released to the Fund, however could not be released to the member. For this reason, own occupation TPD can no longer be applied for in the superannuation environment.
- insurance premiums tax deductible to the Fund
- improved personal cash flow – can use existing accumulated superannuation benefits to pay for premiums
- creates a tax-effective option of funding insurance via salary sacrifice
- benefit can be paid in the form of a concessionally taxed income stream; and
- tax deduction for premiums can offset “contributions tax” in the Fund.
- benefits may be subject to tax
- access to benefits may present a problem – criteria for release of TPD benefits may differ between super Fund/law and insurance provider
- some product features may not be available; and
- time delays occur as a result of Trustee process.
Income Protection Insurance
Income protection insurance provides a regular income stream in the event of a member’s temporary disability.
- insurance premiums tax deductible to the Fund
- tax deduction for premiums can offset “contributions tax” in the Fund; and
- Income Protection Insurance held outside super is also tax deductible with no impact on contribution limits.
- policies held inside super may not offer all features of non-super due to sole purpose test
- super contributions made to pay for premiums will count toward contribution limits
- group rates provide for cheaper premiums; and
- improved personal cash flow – can use existing accumulated superannuation benefits to pay for premiums.
As of July 2014, Trauma policies cannot be held inside the superannuation environment. There are grandfathering rules for policing held inside superannuation prior to this time, however no new policies can be applied for.
As a trauma event is not in itself a condition of release, holding trauma cover inside a superannuation fund would create a situation where insurance benefits are released to the fund, however cannot be released to the member. Hence the decision to no longer allow for Trauma policies to be held in superannuation.
What to do?
It is recommended that specific advice be sought as to each member’s personal circumstances and whether any of the above types of insurance available within SMSFs should be acquired inside or outside a Fund. Particular attention should be given to whether a deduction is able to be claimed for the insurance premiums and also the potential tax implications for both members and beneficiaries if and when an insurance benefit becomes payable.
McQueen Financial Group is a corporate authorised representative of Total Financial Solutions Limited. AFSL No. 224 954, ABN 94 003 771 579. This information is of a general nature only and does not consider your investment objectives, financial situation or particular needs. You should not act on any information in this report without first consulting a professional investment adviser in order to ascertain whether the information and any investment decision is appropriate. This information is believed to be accurate however no warranty of accuracy or reliability is given in relation to any advice or information contained, and neither TFSA or its Representatives and officers, agents or employees of either of the aforementioned shall not be held liable for any loss or damage whatsoever arising in any way for any representation, act or omission, whether express or implied (including responsibility to any persons by reason of negligence).