Self-managed super fund life insurance
Learn about how SMSF life insurance differs from stand alone policies, its tax rules on premiums and its benefits and drawbacks
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 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:
- General life insurance. Provides a lump sum pay out in the event of the policyholder's death or if they are diagnosed with a terminal illness.
- Total and permanent disability (TPD) insurance. Provides a lump sum pay out if the policyholder is permanently disabled and is unable to work again.
- Income protection insurance. Pays a monthly benefit to cover ongoing expenses in the event the policyholder is unable to work for an extended period of time due to illness or injury.
Life insurance held inside your superannuation differs from stand-alone life insurance in the following ways:
- Trauma insurance is not available.
- 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 cover 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).
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.
- 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.
- 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 30th 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.
Insurance premium payments are generally tax deductible when cover is held through a SMSF. They are deductible to the SMSF rather than to the individual and they include:
- Life Insurance. 30% of premium
- Endowment. 10% of premium
- TPD (Any Occupation). 100% of premium
- Income Protection. 100% of premium.
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.
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.
|Type of TPD policy||Does it meet the conditions of release?||Can I get it inside super?|
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