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Self Managed Super Fund Life Insurance

If you own a SMSF then it's a good idea to consider your life insurance needs and those of 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.

A 2012 report found that only 13% of self-managed super fund (SMSF) members currently having cover1, which is a vast contrast from the majority of retail superfunds that include some level of coverage.

So is life insurance required for SMSF's?

By law, SMSF trustee's must 'consider' the life insurance needs of its members when putting together an investment strategy e.g. checking if its members life cover is already taken care of elsewhere before not providing cover.

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Provides a lump sum payment if you become totally and permanently disabled and are unable to return to work.
Provides a lump sum payment if you suffer a serious medical condition. Cover can be taken out for 40-60 medical conditions depending on the policy you choose.
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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:

Life insurance inside or outside super; whats the difference?

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).

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 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.

Taxation under SMSF life insurance

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.

Final things you might want to know about

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).
Image source: Shutterstock

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William Eve

Will is a personal finance writer for finder.com.au specialising in content on insurance. While he cannot give personal advice to clients, Will enjoys explaining the intricacies of different types of protective cover to help individuals and businesses find affordable cover that won't leave them underinsured.

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