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Don’t drain all funds post terminal diagnosis

SMSF terminal illness

SMSF trustees diagnosed with a terminal illness should not empty their member balance as retaining some funds is necessary to ensure insurance benefits can be paid.

Advisers should warn trustees who have been diagnosed with a terminal illness and have received insurance benefits within the fund to maintain a small balance in the SMSF to ensure they, or their beneficiaries, can claim any future insurance benefits.

Speaking during a recent online presentation, Smarter SMSF chief executive Aaron Dunn said insurance benefits from the life insurance policy paid by an SMSF could be lost if the trustee does not exercise caution regarding the deed and terminal illness regulations.

To further clarify, Dunn provided an example in which a 46-year-old woman has been diagnosed with a terminal illness and has less than two years to live. The individual has $150,000 in super and a $2 million life insurance policy.

“The life policy that is owned by the fund contains a clause that allows for up to $1 million to be paid in the event of a member being diagnosed with a terminal illness,” he said.

“We’ve got a split here between what is the death benefit and then what might be a part payment that deals with terminal illness at a particular point in time. So in this instance, we go through the evidentiary process and the paying insurer determines to pay out $1 million into the fund.”

He said the member would be eligible to take all the money out of the SMSF as a tax-free lump sum based on the condition of release of a terminal medical condition, but without an account balance would no longer be a member of that fund.

“As a result of that action there may no longer be any entitlements to any benefits in that fund. Therefore in this instance, her beneficiaries may miss out on that additional $1 million because that policy is no longer relevant in this context,” he said.

To remain a member, he suggested trustees who have received an insurance benefit should keep a small balance in the fund in order to keep the member account open, but this would be dependent on what the deed states in regards to membership.

“It would be best, as an absolute minimum, to retain a small balance in the fund to keep the member account open and ensure that it can continue to pay and meet expenses and obligations, such as insurance premiums, when they fall due,” he said.

“Otherwise, we may risk the fact that the policy exclusions and the like will mean the insurer doesn’t have an obligation to pay out [any remaining] amount.”

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