Choosing whether to use an accumulation or pension account in an SMSF to pay life insurance premiums will depend on how a member wants to receive any benefits that may be paid in the future, according to a leading education provider.
Speaking during a recent webinar Heffron SMSF technical and education services director Leigh Mansell said members should consider the “endgame” and work backwards when deciding where to take life and total and permanent disability (TPD) insurance premiums from when they have both types of accounts in operation.
“The rule of thumb is if you pay a premium from a particular account balance, the super rules include fair and reasonable requirements in relation to the proceeds in the event a claim is successfully made and the fund receives insurance proceeds as an investment return,” Mansell explained.
“If a premium gets deducted from a particular account balance, then it’s only going to be fair and reasonable after a successful claim the proceeds get allocated to that same account balance, so we need to match up the premiums with the proceeds and make sure they go in and out of the same account.”
She noted the end result of this approach from a tax perspective differed depending on whether the claimant was alive or dead and what account had been used to pay premiums.
“If the member is still alive and you’ve paid the premiums from the accumulation account, when a claim is made the proceeds come into the accumulation account and will be a taxable component,” Mansell indicated.
“It’s different if the member is in pension phase and pays the premiums from the account-based pension (ABP).
“If I have an ABP that is 20 per cent tax-free and my fund trustee makes a claim on a TPD policy in relation to me and $1 million comes into the fund, that needs to be credited to my ABP and will take on the tax-free component of that pension.
“If the client instead had died and we are dealing with proceeds from a life insurance policy that member’s accumulation account had paid for, the proceeds would be allocated to their accumulation account and have a taxable component.
“However, if the member was in pension phase, how does it work when we are dealing with the tax components of the pension if it reverts on death?
“If the pension was 20 per cent tax-free and reverted on death, the insurance proceeds will take on the tax-free components of the pension in relation to that reversionary pensioner.
“So, we have a situation where there are some good things with paying premiums out of a pension account when somebody has died, but it’s only useful where you make a claim and it’s probably the unusual event that you do make a claim.
“If you don’t make a claim, you have a pension balance that you have to make payments out of as well as pay insurance premiums and inevitably you are going to start eating that pension account balance faster.”
