Insurance in superannuation has been the growth story of the Australian life insurance market for the past three years. In 2016, insurance in superannuation accounted for more than 50 per cent of TAL’s retail insurance sales.
While insurance growth in the SMSF market has traditionally been lower than the insurance in superannuation market, in certain circumstances there are advantages of holding insurance cover inside a client’s SMSF.
Insurance in super growth drivers
There are two major drivers behind the growth of insurance in superannuation, which can also be advantages for SMSF members with insurance needs.
The first driver is premium affordability. Insurance in superannuation allows clients with cash-flow issues to access life insurance cover using their balances in superannuation to fund the cost.
The second driver is the tax deduction associated with the cost of cover. Insurance in superannuation can be funded using deductible contributions. This reduces the cost of cover by the client’s marginal tax rate. Outside superannuation, there is generally no tax deduction for the cost of cover.
SMSF members and the two-stage process of insurance in super
Insurance in superannuation involves a two-stage process to determine the validity of claims:
- If the claim is valid in terms of the policy, the claim proceeds are paid to the trustee of the superannuation fund as the owner of the policy.
- The trustee of the superannuation fund then has to determine whether or not the benefit can be paid to the member of the superannuation fund or beneficiary. The trustee in making this determination is required to apply the relevant Superannuation Industry (Supervision) (SIS) provisions, in particular the conditions of release.
This two-stage process also applies to insurance held via an SMSF. However, in the case of the SMSF, the members control the trustee, and therefore have greater input in ensuring the speedy and efficient completion of the second stage of the process.
SMSF trustees can only release benefits to members if the payment of those benefits is in accordance with the SIS provisions.
SMSF members can mix and match
There is no requirement for SMSF members to place their insurance needs in an SMSF, but most members would probably choose the simpler option of placing both their retirement savings and life insurance within the same SMSF.
There may, however, be instances where segregation of the two elements is desirable.
For example:
- The life insurance claim proceeds may be earmarked for a special purpose, such as providing seed capital for a testamentary trust in favour of certain heirs, while the death benefit from the SMSF may be earmarked for another class of beneficiary. In this case, it may be appropriate to hold the life insurance cover outside the SMSF.
- The tax benefits associated with total and permanent disability (TPD) insurance may be higher if the cover is taken in a retail insurance fund. This is because TPD benefits from super are taxed on a formula basis. The tax-exempt portion is calculated by multiplying the benefit payment by the ratio of the days from payment date to retirement date over the total number of days from the start of the eligible service period to retirement date.
In the case of a person in their fifties, the days to retirement diminish until they reach the age of 65 (the usual retirement age). For these individuals, the eligible service period is also increasing as they age. The combination of these factors results in a higher taxable component in the event of a successful TPD claim and if the cover is taken in a retail insurance fund, the tax-exempt portion of the TPD claim will be greater for these individuals.
In the case of placing the TPD benefit through the SMSF, the membership period will go back to the date of joining the SMSF, and possibly further where the member seeded the SMSF by a rollover from an industry or retail fund.
SMSFs and the 15 per cent rebate offered by insurance in super
The 15 per cent rebate associated with insurance in superannuation is also available to SMSF members. It is possible for SMSF members to access the superior cover and benefits offered by products such as TAL Accelerated Protection using this rebate mechanism.
An amount can be rolled over by the SMSF to a retail superannuation fund and the amount rolled over under these arrangements is generally the cost of the cover sought reduced by 15 per cent.
SMSF members need to consider carefully whether or not the rollover strategy gives them any advantage. The cover can be provided within the SMSF by paying the premium directly to the insurer. In this case, the SMSF claims the premium as a tax deduction.
This arrangement carries the same after-tax cost as the rollover arrangement without the complexities associated with a rollover.
Way forward
Over the coming months, SMSF members should evaluate their insurance needs and consider them in light of the federal government’s changes to the superannuation system effective 1 July 2017.
Where insurance needs have been identified, SMSF members should consider whether or not insurance held via their SMSF or another superannuation vehicle is appropriate.
Superannuation and insurance environments are evolving, and will continue to evolve in spite of the ideology of the incumbent government.
While insurance in superannuation can present substantial opportunities and efficiencies, it is always important to consider the potential pitfalls for the SMSF member.