If you manage a super fund then it's a good idea to consider the life insurance needs of both yourself and your members.
Life Insurance is an important means of ensuring your loved ones are provided for financially if you die or are permanently incapacitated. It is something everyone should have, either inside or outside of super, and with only 13% of self-managed super fund (SMSF) members currently having cover, the government is trying to encourage higher numbers of people who manage their own super to take out life insurance.
The cover is purchased and owned by the SMSF trustee, who pays a benefit to members who satisfy a condition of release such as death or disablement. While trustees are not yet required by law to have cover in their funds, they are at least required to consider it for their members and this guide looks at the advantages and disadvantages of holding Life Insurance through an SMSF.
The life insurance policies available inside super
The same life insurance policies people purchase outside of superannuation can be obtained by those who take out self-managed super fund life insurance, with one exception; trauma life insurance, also known as critical illness life insurance, cannot be taken out through a SMSF. The policy types that are available inside super are:
Basic cover is automatic, with no medical examinations required.
Premiums are tax deductible, unlike life insurance held outside of super.
Income protection inside super usually only provides two years worth of cover.
A condition of release must be met before a benefit can be paid on life cover inside super.
Insurance inside super is often cheaper, due to the bulk buying power of superannuation funds.
Premiums don’t have an impact on immediate cash flow, as they are paid by the super fund, not directly out of your pocket.
Benefits paid go to the fund, which then distributes them to the beneficiaries, so there can be lengthy delays in receiving benefits.
Life insurance inside super generally only includes basic cover with smaller benefit amounts, so the amount of cover you can get could be less than what you require.
TPD insurance is only available for Any Occupation, not for Own Occupation (i.e. you must not be able to perform any occupation you are reasonably suited for, rather than just your previous occupation)
A TPD benefit payment outside of super is tax free, while a benefit payment inside super is taxed under the lump sum superannuation payment rules. The amount of tax payable will depend on your years in the fund and how long you have until retirement (the longer your membership and the closer to retirement, the higher the tax).
Finder survey: How many Australians of different ages have life insurance inside their super?
Response
75+ yrs
65-74 yrs
55-64 yrs
45-54 yrs
35-44 yrs
25-34 yrs
18-24 yrs
No
91.38%
62.86%
52.91%
34.72%
28.93%
33.94%
45.36%
I don't know
6.9%
10.86%
8.14%
12.95%
11.17%
14.68%
25.77%
Yes
1.72%
26.29%
38.95%
52.33%
59.9%
51.38%
28.87%
Source: Finder survey by Pure Profile of 1110 Australians, December 2023
What are the benefits and drawbacks?
SMSF life insurance offers both benefits and drawbacks, which must be weighed up before deciding whether to opt for cover inside your fund or as a stand-alone policy.
Benefits
Unlike cover through regular superannuation, SMSF life insurance can be tailored to meet the needs of each member of the fund, thus reducing the risk of being underinsured.
There is a significant tax advantage to taking out life insurance through your SMSF, as super fund premiums are tax deductible if you’re self-employed or earn less than 10% of your income as an employee.
Some SMSFs can also claim a separate one-off tax deduction not available to other types of super funds, which can be used to reduce tax on capital gains, investment earnings and taxable contributions.
A SMSF relies on ongoing member contributions to repay loans and other debts. If a member dies, the life insurance pay out can help the fund continue to make its repayments without being forced to sell off assets.
Drawbacks
While death benefits paid to dependent beneficiaries (i.e. your spouse) are tax-free, tax is payable on pay outs to beneficiaries who are independent adult children (up to 31.5%).
All pay outs from SMSF held life insurance must now satisfy a condition of release, otherwise they may be held in the fund. This means own occupation TPD insurance does not qualify for cover inside a SMSF (this rule does not apply to funds established prior to June 30, 2014).
Life insurance through a SMSF only covers the core benefits. Ancillary benefits like advance funeral payments, grief counselling, financial planning and accommodation are usually not available.
Life insurance may be more expensive through a SMSF because it doesn’t have the bulk buying power enjoyed by retail and industry super funds.
SMSF members may be required to undergo a medical examination to qualify for cover, unlike life insurance held through a regular super fund.
As an alternative to claiming a deduction on premiums, some SMSFs claim a deduction for ‘future liability’. If a member dies or becomes disabled and a benefit is paid by the trustee, they can choose to not claim a deduction on the premiums paid, but instead claim a deduction on the ‘future service’ of the benefit payment. The tax deduction is calculated as Benefit Amount (amount of lump sum) x Future Service Days (days from member’s termination to age 65) / Total Service Days (the sum of future service days plus the members eligible service period to the day of termination).
Choosing this type of deduction depends on the particular circumstances of the SMSF, as once the trustee has elected to take it, the choice is permanent. That's why this option is unique to SMSFs, as no regular super fund would take such a deduction for one member and lose the ability to claim premium deductions for all its other members.
Can I get TPD insurance inside an SMSF?
The short answer to this question is yes. However, super funds as of 2014 can only offer 'any occupation' TPD insurance, as opposed to 'own occupation' cover you can secure from some retail life insurance policies.
Be aware that in order to successfully claim a benefit under this type of super fund policy, you have to satisfy two conditions:
Compliant policy wording. Your super policy must have industry-compliant definitions of total and permanent disability, including death, terminal illness, and permanent or temporary incapacity. Policies taken out after July 2014 are broadly compliant, but policies from before this date may prove impossible to claim on due to old definitions.
Be unable to work. Because super funds offer 'any occupation' cover, you must not only be unlikely to ever be employed again in your own industry, but in any industry or job reasonably suited to your education, experience and qualifications. This in particular can make successful claims difficult.
Frequently asked questions about insurance inside a SMSF
If the members have existing cover outside of super, if they would be subject to detrimental underwriting exclusions or loadings or are retired and have little debt and sufficient retirement savings.
No, a personally-owned policy must be terminated and re-issued under the ownership of the SMSF, providing there are no underwriting issues.
The claim is paid to the trustee of the SMSF, who can only release a benefit to a member if a condition of release is met (i.e. death or permanent disablement).
Because there is generally no available condition of release (death or disablement), which means the benefit would remain trapped in the fund until the member’s preservation age.
Authority from the ATO to pay a debt, leaving Australia permanently after expiry of a temporary visa, turning age 65 or becoming permanently incapacitated or diagnosed with a terminal illness (less than 12 months to live).
Money paid towards premiums for TPD insurance is usually 100% tax-deductible, provided the policy is compliant (as explained above), and the policy contains an appropriate definition related to the loss of independence in daily living. These definitions were updated most recently in 2014, so if your policy dates from before then it's worth reviewing your cover. And if it is an "own occupation" policy and it conforms to these definitions, it is usually 67% tax-deductible or 80% if bundled with eligible life cover.
When you make a successful claim on your super TPD policy, the benefit payment will be sent to the SMSF trustee. So long as you've met a 'condition of release' - death, terminal illness, or a permanent or temporary disability - the benefit can then be passed onto you or your beneficiaries.
The benefit may be paid as a lump sum or as a regular income stream. A lump sum benefit may be subject to harsher taxes than the income stream option.
Willam Eve is the country manager for Finder's Canada operations. He has previously held the positions of group publisher of insurance for Finder Australia and lead publisher for the Finder global team. William has a Bachelor of Communications from the University of Technology Sydney, Australia. He loves the challenge of launching Finder into new markets while helping grow Finder’s global team. See full bio
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