Insurance in superannuation
Insurance in superannuation funds
The primary purpose of a superannuation fund is to provide retirement benefits to members. But these funds can also pay death benefits to members’ dependants and other ancillary benefits, such as those to assist members who have become physically incapacitated, and the role of the financial professional in ensuring appropriate insurance policies are in place is paramount.
Fulfilling the sole-purpose test for industry and retail superannuation funds implicitly requires the fund trustees to provide access to some level of death, total permanent disability and income protection insurance. Most of these funds have group life insurance policies available that provide cover, usually at a lower premium and with lower underwriting requirements than individual policies.
Self-managed superannuation funds (SMSFs) do not have access to group life insurance facilities and the trustees must arrange individual policies on the lives of members. Providing such life insurance policies within an SMSF allows for tax deductibility of the insurance premiums and this is not generally available for death, total permanent disablement or trauma insurance. Income protection insurance is tax-deductible outside superannuation.
Death cover
Trustees of the fund can deduct all the premiums for death cover using term life insurance. Thirty per cent of the premiums for death cover using a whole of life policy are deductible. On the surface, having death cover provided by an SMSF seems sensible, but it is important to look beyond the tax deductibility of premiums and consider the estate-planning implications.
A death benefit received by a superannuation fund and paid to dependants will be tax-free in their hands. However, to the extent that it is paid to non-dependant beneficiaries, it will be apportioned into taxable and tax-free components based on the member’s benefit components. The tax-free components will be paid to the non-dependants tax-free and the taxable component will be taxed at 16.5%.
Particularly with industry and retail funds, there will be some delay in paying out death benefits because the trustees will take time to determine who is a dependant and who is not.
A death benefit policy held outside superannuation does not give access to tax deductibility of some or all of the premiums. But upon the death of the insured person, the benefits go straight to the owner of the policy – no delays and no tax applicable.
There is a good argument for having death cover both inside and outside the fund at the same time. The right choice depends on the member’s situation.
Insurance policies already held by superannuation fund members cannot be transferred to the ownership of the trustees of a fund unless the policy is a term life policy, which only has a contingent right to receive a benefit. A life insurance policy that has a surrender value does not fit the definitions of an asset that may be purchased from a member.
Total permanent disablement cover (TPD)
Generally, TPD cover is attached to death cover and the premiums have usually been tax-deductible in full. TPD will be paid by the insurer to the fund based on the definition of TPD in the policy – either the person insured will be unable to carry on their usual occupation (the “own occupation” definition) or any occupation for which they are suited by education, training or experience (the “any occupation” definition).
The TPD definition in the Superannuation Industry Supervision (“SIS”) legislation is that of “any occupation”. So unless the member meets the narrower “any occupation” definition as well as the “own occupation” definition, the trustees of the fund may not be able to pay the insured TPD benefit to the member until a later condition of release (reaching preservation age) has been fulfilled.
For the 2012 and later financial years, the deductibility of premiums has changed and only that part of the premium that provides cover with an “any occupation” definition in accordance with SIS is tax-deductible. This requires either re-arrangement of insurance cover within the superannuation fund or obtaining an actuarial certification.
Note that even some benefits payable under “any occupation” policies may not be payable to super fund members. For example, “loss of limbs” or inability to undertake “activities of daily living” do not fit the SIS definition of TPD.
In response to this change, some insurers are developing “dual definition” policies with the premiums split between “own occupation” cover and “any occupation” cover. The “any occupation” cover can be held and paid for by the trustees of the superannuation fund and the “own occupation” cover can be held and paid for outside the fund by the life insured. These policies are not likely to be available in group life insurance situations through industry and retail funds.
Income protection insurance
Income protection insurance covers temporary disability of the person insured. Premiums are generally deductible in the fund if the cover is for a period of two years or less, although recently the Australian Taxation Office has allowed premiums to be deducted if the cover period is greater than two years.
Many corporate, retail and industry superannuation funds provide access to salary continuance cover, especially for executive and management employee categories.
However, for members of SMSFs, there are no real advantages for having income protection cover held within the fund. Premiums for cover held outside the fund are tax-deductible to the individual members and wider definitions of temporary disability and cover through to age 65 are available.
Trauma insurance
A Tax Office Ruling in 2010 stated that under certain circumstances, the trustees of a fund may own a trauma insurance policy on the lives of the fund members without breaching the sole-purpose test.
However, premiums for trauma insurance are not deductible to the trustees of superannuation funds and benefits received as a result of a claim may not be able to be paid to the member until a condition of release has been met. Trauma cover is best held outside superannuation.
Summary
Insurance available through industry and retail superannuation funds is very different to that available to the trustees of SMSFs. Careful analysis of the advantages and disadvantages of the various types of policy, and how they should be owned, is essential before they are initiated. The considerations go beyond mere tax-deductibility of premiums, for example, the importance of estate planning considerations should not be forgotten.
Please contact us if you have any questions.