Where will your life insurance end up?
Life insurance is all about looking after your loved ones when you’re gone, but after taking all the necessary steps to purchase a policy, it’s quite surprising how many Australians fail to ensure that they know where their benefit payment will end up.
A range of different implications need to be taken into account depending on whether:
- Your policy is held in your own name
- You have named any beneficiaries
- Your cover is held through your superannuation fund
Each approach to distributing your life insurance proceeds has its own risks and rewards, and there are certain traps that need to be avoided – traps that can mean the difference between the funds going straight to your family and being used to pay off outstanding debts.
Here's how proceeds are distributed:
|Where are proceeds paid?|
|1. If the policy is held in your own name||First to your estate, then distributed according to your will.|
|2. You have named a beneficiary/beneficiaries||Skips your estate, straight to the named person/persons.|
|3. Your cover is held through your super||Either your estate or someone who qualifies as your dependant under superannuation law.|
How can the proceeds of my life insurance be used?
The proceeds from your life insurance can be used by your family to pay off the mortgage and other debts, cover the cost of your funeral, pay school fees and generally be used to maintain their current standard of living.
If the life insurance policy was taken out in your name, any benefit payment it offers will go to your estate and be distributed based on the information contained in your will. This means that it’s important to specify in your will where you want the funds to go. If your will contains no mention of how the money is to be spent, the benefit payment will pass to your residual estate, which means it will be paid to your residual beneficiaries (the people identified in your will who will receive what is left of your assets after all other debts have been paid).
Who receives the payment in I have outstanding debits?
If you have outstanding debts against your name when you die, the assets of your estate could be used to pay out those debts. As a result, your loved ones could miss out on the proceeds from your life insurance policy. And if you have any family members who are not adequately provided for in your will, they may launch a legal challenge to your will and take some of the life insurance payout.
To ensure your proceeds go to who you intend, consider including a testamentary trust in your will.
If you decide to name a beneficiary on your life insurance policy, the proceeds of any benefit payment will bypass your estate and go directly to the person you nominate. For example, you may wish the benefit payment to go directly to your spouse so you will nominate him or her as the beneficiary of your policy.
In some cases this approach can raise its own problems. For example, your beneficiary may opt to use the proceeds to pay off their own debts and liabilities, or they may have just turned 18 and be unable to sensibly manage such a large amount of money. You’ll need to take your own, and your family’s, circumstances into account before you decide how you want the proceeds of your life insurance policy to be distributed.
Including a testamentary trust in your will can have many benefits if you decide to have your life insurance benefits paid directly to your estate. This is designed to ensure that any aims you have for your life insurance are satisfied. A testamentary trust:
- Allows you to outline how and when the proceeds from your life insurance will be distributed. This lets you nominate your intended beneficiaries. For example, you may decide that your 18-year-old nephew should receive his share of the proceeds in instalments over a period of time
When deciding on how the proceeds of your life insurance policy will be distributed, it’s also important to consider the tax implications of your decision. These will vary depending on whether your policy is held inside or outside super.
|Policy type||Are proceeds taxed?||*Conditions|
|Outside of super||No*||Only under the two key exemptions|
|Inside of super||No*||Beneficiaries must be your financial dependants|
For policies held outside super
The first is that no CGT will need to be paid if the life insurance proceeds are paid to the original beneficial owner of the policy. Original beneficial owner is a confusing term, but an accurate definition can be found in Tax Determination TD 94/31:
“… the original beneficial owner is the first person who ... holds the rights or interest, and possesses all the normal incidents of beneficial ownership, for example, who is entitled to the benefits of the policy proceeds and has the power of management and control over the policy ....”
The second exemption is available if the recipient of the proceeds was not an original beneficial owner, but they did not pay any fees to purchase the life insurance policy.
For policies held inside of super
Beneficiaries who are not financial dependants will need to pay tax on the benefit payment at a rate of up to 30%.
With each and every passing day our lives and personal circumstances change. We change jobs, get promotions, move house, get married, have children and generate our own share of assets and liabilities. With this in mind, what was acceptable life insurance cover for you five years ago may be completely inadequate now.
- Ensure you have enough cover. Regularly reviewing your life insurance cover is an important step for every policyholder. It’s always vital to ensure that you have enough cover in place to take care of any financial obligations and provide for your family if you were to die unexpectedly. The life insurance market is quite competitive and you may be able to find a policy that offers better cover and better value for money.
- Make sure the right people are covered. It’s equally crucial to update the nominated beneficiaries on your policy. Your children may have left home and started families of their own, so you may want to extend the amount of benefits they receive. Alternatively, you could have gone through a divorce and need to alter the terms of your policy to reflect your changed circumstances.
A Grant of Probate is usually simply referred to as ‘probate’ and is an important certificate granted by the Supreme Court. This certificate confirms that a deceased’s will has been proved and registered by the Supreme Court, and also that the executor listed in the will has been granted the right to administer the estate. In other words, this legal document authorises the executor to take care of all issues relating to the deceased estate.
In most cases, the executor will ask their solicitor to lodge their probate application with the Supreme Court’s probate registry. The solicitor will need to prepare a range of legal documents for lodgment, including the will, the death certificate and a statement of all the deceased’s assets and liabilities.
The distribution of assets from an estate can only take place once any claims against the estate have been settled and as soon as the following steps have been finalised:
- Receipt of the Grant of Probate
- All of the estate’s assets have been gathered by the executor
- As instructed in the will, the executor has sold any assets, property or shares
- Any debts and liabilities of the deceased have been settled by the executor
- The deceased’s final tax return has been lodged and a notice of assessment has been received
There are additional implications If you hold cover through your super fund and nominate a beneficiary. Most super funds let you choose who the proceeds of your policy will go to, either as a binding or non-binding nomination. Failure to nominate anyone will mean it is up to the super fund trustee to decide where your money goes.
If you make a binding nomination (you can choose either one or more dependants or your legal representative), the fund trustee must pay the benefits as per your instructions. However, a non-binding nomination only acts as a guide for the fund’s trustee as to who should receive your benefits – the trustee makes the final decision as to where your money goes.
Regardless of whether you hold your life insurance inside or outside of super, it’s crucial that you take steps to guarantee that your policy’s proceeds will go to the right people. Taking a bit of time to do this now will offer you peace of mind well into the future.