Insurance: Inside versus Outside Super
Holding insurance provides protection against many of life’s ‘what if’ events. For many people, insuring their health and ability to earn an income is a top priority. There are a range of ownership structures for insurance policies. However, where insurance is to be taken out by an individual there are two main options to consider: inside or outside superannuation.
Owning insurance inside super provides advantages in terms of tax efficiency and affordability. However, it can lead to a significant trade off; less money may be available for retirement savings and there may be additional requirements to be able to access the funds in the event of making a claim. When evaluating insurance inside or outside super, financial advisers need to consider a range of factors, from the type of insurance held, to the impact on taxation of benefits and a client’s cash flow.
PROTECTION AGAINST THE UNKNOWN
From cars to home contents to travel, virtually everything we own is insurable. For most people, protecting their ability to earn an income or provide for their family are top priorities. Life insurance is one of the best ways of doing this, as it provides financial security for a person’s dependants in the case of an unforeseen event.
There are countless permutations of policy ownership on offer including ‘self ownership, cross ownership, trust ownership, corporate ownership and super fund ownership.’ However, where insurance is taken out by an individual, there are two main options: inside or outside superannuation.
When insurance is held inside super, the trustee of the super fund owns the insurance policy on behalf of the super fund member. Premiums are paid through super contributions or the account balance of the fund. In the event that the proceeds of any insurance policy are paid out, these are paid into the member’s account in the super fund and must meet certain conditions before they are remitted on to the member or their beneficiaries.
In contrast, where insurance is owned by an individual, there are fewer restrictions surrounding payments. A person will pay a premium themselves or through their employer, with the proceeds paid directly to the policy owner or a nominated beneficiary once an event occurs.
The most appropriate type of insurance to hold and ownership structure to use is the subject of perennial debate. For financial advisers, it is important to understand the pros and cons of insurance held inside versus outside super, as well as the implications on a client’s cash flow, tax and access to benefits.
INSURANCE INSIDE SUPERANNUATION
The main types of life insurance that can be held within super include:
>> Term life/death cover that provides a lump sum benefit in the event of a person’s death.
>> Total and permanent disablement (TPD) that provides a benefit if a person becomes totally and permanently disabled and is unable to work.
>> Income protection/salary continuance or disability insurance that provides a regular income payment of up to 75% of a client’s regular income if they are unable to continue to work due to illness or injury.
>> Trauma that provides a lump sum benefit or instalments if a person is diagnosed with a specific illness or meets a certain medical condition such as stroke, heart attack or cancer.
Whether these policies are held inside or outside super will affect the way they function. Each type of insurance is examined in greater detail below.
Term life insurance
Term life insurance or death cover is designed to ensure a person’s dependants are financially secure following their death. Matthew Esler, Executive Director of Strategy and Technical Services, Midwinter Financial Services, said the proceeds of the policy are generally paid to the owner of the policy on the death of the life insured.
The owner of the policy could be the life insured person; it can also be jointly held between a life insured and a third party or it can be held by a third party completely.
For life insurance inside super, the owner of the insurance policy is the super fund trustee. Any claims paid out by the life insurer will be paid into the super fund, then remitted on to the dependant(s), in accordance with the Trust Deed and conditions of release under the Superannuation Industry (Supervision) Act 1993 (SIS Act).
It is possible for a superannuation fund member to nominate one or more beneficiaries to receive their death benefit — including any insurance cover paid. This may take the form of a binding or non-binding nomination. If there’s a [valid] binding nomination [the payment] will go to the nominated beneficiary or if there is no binding nomination, the trustee uses their discretion to pay it according to what the trustee deems will be the rightful beneficiary.
Where no nomination exists, the trustee will use their discretion to determine the appropriate recipient of the death benefit in accordance with the governing rules of the superannuation fund.
Total and permanent disability (TPD)
TPD can be purchased in combination with term life insurance or on its own. There are two main definitions of TPD that can be held inside super: ‘any occupation’ and ‘own occupation’.
Under any occupation TPD, a benefit is paid if the insured person is unlikely to regain employment in any business or occupation for which they are qualified through their education, training or experience due to their physical or mental health.
Under own occupation TPD, a benefit is only paid if the insured person is unlikely to ever be gainfully employed in their own occupation as a result of the event they have suffered.
Generally, own occupation TPD is more expensive than any occupation although a benefit payment is more likely to occur in circumstances where a claim is made. However, if own occupation TPD is held inside super, clients may find it difficult to have their proceeds released, as the event that triggers the TPD payment may not match the definition of permanent incapacity under the SIS Act.
It’s quite a dangerous position to be in, especially if I’m actually suffering some sort of TPD event. This is because the benefit may not be paid out until another condition of release is met, such as reaching preservation age or no longer being gainfully employed.
Trauma
Holding trauma insurance inside super is similarly contentious, due to questions surrounding whether the event that triggers a trauma payout will match conditions of release under the SIS Act. As well, there is a more general concern about whether holding such a policy is consistent with the sole purpose test.
The whole purpose of superannuation benefits is to provide for a member in the event of their retirement or death or TPD … so in that sort of situation [trauma] doesn’t really fit as nicely as some of the other insurance benefits in terms of satisfying that definition under the sole purpose test.
Consequently, trauma insurance is more commonly found in SMSFs. The Australian Tax Office’s 2009 Draft Self Managed Superannuation Funds Determination SMSFD 2009/D1 states that an SMSF may be able to purchase trauma insurance and still satisfy the sole purpose test. This is provided that any insurance benefits payable:
>> are required to be paid to a trustee of the SMSF
>> will become part of the assets of the SMSF at least until such time as the relevant member satisfies a condition of release; and
>> the acquisition of the policy is not made to secure some other benefit for another person such as a member or member's relative.
Income protection
Income protection insurance offered through super is often referred to as ‘group salary continuance insurance’. Proceeds are generally paid as an income stream after a designated waiting period has been met, usually between 30 and 90 days.
Disability benefits must be paid under the SIS Act as a non-commutable income stream so that it can be paid to the member or the legal person or representative of that member in certain circumstances.
Previously, superannuation funds were only permitted to claim a tax deduction for premiums relating to income protection policies which provided for a maximum two-year benefit period, and as such most funds only offered this limited type of cover. Recent changes mean that the tax deduction extends to all eligible income protection policies, meaning that clients can elect a longer benefit period, including one which extends until age 65.
Holding income protection inside super can be useful for those who don’t want to use their disposable income to pay for premiums, which can be quite expensive.
When you compare income protection inside super to income protection outside super the tax outcome is actually exactly the same; you don’t have advantages on either. However, you can use your account balance that you already have in super to pay for the premiums for income protection inside super.
However, as super is primarily designed to build retirement savings, this may mean funds offer ‘no frills’ income protection policies.
Whenever a fund trustee offers something through their fund, they need to be aware of the sole purpose test. That means for some insurance policies you may have a pared down version of the policy they would offer outside super just to ensure there are no extra features that may breach the sole purpose test.
For instance, where clients hold income protection outside super, they may be able to gain ancillary benefits that top up a client’s income beyond 100% of their pre-disability income, whereas clients may not be able to select or receive these extra benefits where the policy is held through superannuation.
In addition, clients who are unemployed, on sabbatical or maternity leave may not be able to receive benefits under an income protection policy held in superannuation due to the provisions in the SIS legislation regarding payments.
ADVANTAGES AND DISADVANTAGES
Advantages
The main advantage of insurance inside superannuation is tax efficiency. As premiums are paid from a client’s contributions from pre-tax income, and super funds can claim a deduction for most premiums, this is more affordable and less disruptive to a client’s cash flow.
This means clients are simultaneously getting tax advantages and using less of their gross income to pay for insurance.
I can actually pay for the premium from benefits within the superannuation fund, from SG contributions being made by my employer and I get that additional tax advantage in that those premiums that have been paid are being paid pre income tax.
Another consideration to take into account is that where personal non-concessional contributions are made, clients may also qualify for aGovernment co-contribution of up to $1,000. This can help compensate for the cost of insurance premiums reflected in a reduced account balance.
The following case studies outline how using a policy within superannuation can make insurance cover more affordable both for clients on a high and a low income.
Case Study 1: Insurance inside versus outside super for high-income earners
David is 42 years old and earns a salary of $85,000 p.a. He wants to take out life insurance so his wife, Helen will be protected in the event that he is to pass away. As Helen meets the definition of a dependant under the Tax and SIS Acts, she would be able to receive this payment as a tax-free lump sum.
The level of cover David would like to take out will require an annual premium payment of $1,200. The amount David pays will differ depending on whether he takes this inside or outside of super.
Outside super Inside super
Pre-tax income needed $1,951 $1,200*
Post-tax income needed $1,200 $738
(38.5% marginal tax rate)
* This assumes the fund passes on the 15% tax deduction they receive from the ATO to the individual
If David paid the insurance premium outside super, he would need $1,951 in pre-tax income to cover this expense. However, if it was held through super, he would only need, $1,200, to cover it. This means he effectively ends up paying only $738 in post-tax income to achieve the same level of cover.
Case Study 2: Insurance inside vs. outside super for low income earners
Jane is 49 years old and works part-time as a para-legal earning $25,000 p.a. She wants to take out life insurance and has found a policy that provides her desired level of cover. The premium is $1,000 per year.
If Jane opts to own this policy inside her super account, she can have the premium deducted from her employer SG contributions of $2,250 p.a. before tax. This means the premiums won’t impact on her cash flow, although it will reduce her super contributions to $1,250 per year.
As an alternative, Jane could make a personal contribution of $1,000 from her after-tax money and, assuming she meets all relevant eligibility criteria, claim the Government co-contribution of $1,000. Jane would now have a total of $4,250 p.a. going into her super fund, with the $1,000 premium resulting in a total of $3,250 before tax. If Jane can afford to pay the $1,000 premium she will be financially better off using this strategy than by paying for insurance outside super.
Self-employed workers who meet all relevant criteria will also be able to claim contributions to super as a tax deduction, regardless of whether they are used by the fund to purchase insurance or investments.
Depending on the underwriting process that is followed by the insurance provider, taking out insurance within super can offer additional advantages for those with a particularly high risk occupation or an existing condition. In such a situation, it may work out that the premium for insurance within their superannuation balance is lower than available through retail cover, if they are pooled with the rest of the people in the fund for the purposes of insurance.
Disadvantages
The main trade-off for holding life insurance inside super is that every dollar spent on insurance premiums is one dollar less invested for retirement.
With many people struggling to replenish their super balance post-GFC and the low contributions caps at present, some clients may be unable to build up enough savings to cover both insurance and superannuation in their fund.
The concessional contributions caps currently sit at $25,000 for the 2010/11 financial year. An increased concessional contributions cap of $50,000 applies until 30 June 2012 for people 50 years old or over, with proposals to permanently maintain this higher cap for members aged 50 and over who have a total superannuation account balance of less than $500,000. The non-concessional contributions caps are $150,000 for the 2010/11 financial year, or $450,000 under the ‘bring forward rule’.
The second major complication of holding insurance inside super is the restrictions on accessing funds, which is governed by the SIS Act.
The SIS Act states that super funds must meet the sole purpose test, under which super funds must be maintained for the sole purpose of providing retirement benefits to members or death benefits to their dependants or deceased estate in the event of their death. A breach of this test could cause a super fund to become non-compliant, potentially leading to significant tax penalties.
Superannuation funds are also not permitted to release benefits to members unless they have met a specified condition of release, such as retirement or reaching age 65. There are some limited circumstances under which a trustee can pay out a benefit prior to either of these events occurring, such as diagnosis of a terminal illness, total and permanent disability or temporary incapacity.
Payments to beneficiaries could be subject to delay as the insured must first meet release conditions of the policy provider and then satisfy conditions of the SIS Act and the Trust Deed of the superannuation fund.
It’s going through two environments and therefore the receipt of proceeds may be slower.
In many cases, the distribution of benefits occurs at the discretion of the super fund trustee. This is one reason that use of a binding death benefit nomination may be an appropriate strategy for term life cover, to ensure the money is paid to the preferred beneficiary.
Clients will also need to consider how they and their beneficiaries may be taxed on the payout, particularly as the definition of dependants differs under the Tax Act and SIS Acts.
Finally, where life insurance is held through an employer fund, clients should consider what will happen to their insurance if they change jobs. If I move from that employer, then I may lose that insurance so you really have to look at the ability to transfer an insurance policy.
TAX IMPLICATIONS
Insurance inside super is renowned for the benefits of paying premiums in a tax concessional environment. However, it is equally important to consider the tax implications for proceeds, as this will affect the end amount a client receives.
You really need to look at the implications in terms of ownership, so whether it’s owned by an individual; whether it’s owned by a third party such as an employer; whether it’s owned by the superannuation fund and look at whether the premium is deductible or not deductible and whether the benefit is assessable or not.
Tax Act versus SIS Act
One of the key elements determining the taxation of benefits is the different definition of dependants under the Tax Act and the SIS Act. The SIS regime dictates who can receive a death benefit from superannuation, but it is the Tax Act which dictates how the benefit is taxed in the hands of the beneficiary.
While children of the member — regardless of age — are considered dependants under the SIS Act and can receive a benefit from the superannuation fund, the situation is different under the Tax Act. Under the Tax Act, in most cases children aged 18 and over are classified as non-dependants, unless they are financially dependent on or can demonstrate an interdependency relationship to the life insured.
The most obvious difference between the two Acts is that a child of any age is treated as a dependant under the SIS Act, but only a child under the age of 18 is considered a dependant for the Tax Act.
In a quite interesting twist, while former spouses are NOT considered dependants under the SIS Act, they ARE considered dependants under the Tax Act and are therefore not liable for tax on any superannuation death benefit which flows through to them, for example, from the estate or from a Superannuation Proceeds Trust.
Care needs to be taken in planning the use of superannuation to hold insurance, as those that are not considered a dependant under the Tax Act may suffer a tax liability up to 31.5%.The following scenarios demonstrate how the tax liability of dependants can affect any proceeds they receive.
Case Study 3: Potential tax liabilities
Positive tax outcome
Harold is 52 years old and has a superannuation fund with an account balance of $150,000 (all taxable component) with $500,000 life cover attached. His wife, Georgia, is his nominated beneficiary. Harold died on 1 November 2010 and the entire $650,000 is paid to Georgia.
Because Georgia is his spouse, she will be considered a dependant under the Tax Act and the payment can be made to her as a tax-free lump sum.
Negative tax outcome
Juliette is aged 63. Her superannuation fund has an account balance of $200,000 (all taxable component) with $300,000 of life cover attached. Juliette is divorced and has nominated her adult children, Francesca and Elliot as joint beneficiaries. As the children are both over 18, not financially reliant on Juliette and therefore non-dependants under the Tax Act, they can only receive the benefit as a lump sum and there will be tax payable on this amount.
If Juliette had held her insurance outside superannuation, Francesca and Elliot could have received the entire death benefit tax-free as such payments are not generally taxed.
CALCULATING THE TAX
Where insurance is held through super, establishing the tax liability on benefits paid from an account is a complex calculation involving both taxed and untaxed elements of the superannuation fund.
It can also vary according to the type of insurance held, the age of the member, the date of their death and who the beneficiary is. As a result, it is best to examine implications separately according to the types of cover.
Term life cover
For term life cover held inside super, premiums are tax deductible and the benefit payment is tax-free if paid to a dependant under the Tax Act.
If the insurance is owned by an individual, premiums are not deductible, but the benefit paid out is tax-free.
Taxation implications for death cover
Superannuation Fund Individual
Premiums Deductible Not deductible
Proceeds Not assessable to fund Not assessable*
* The proceeds are not assessable to the individual and therefore no capital gains tax will be paid on the proceeds unless the beneficiary acquired their interest in the policy for consideration from the original beneficial owner.
However, this is only the first step, as once the benefit is paid out by a superannuation fund, this will be taxed depending on whether the person is considered a dependant for tax purposes and whether they opt to receive the payment as a lump sum or income stream, as well as the composition of the benefit itself.
Where a super death benefit is paid which includes life insurance proceeds, there may be an untaxed element if the fund has claimed insurance premiums as a deduction against the taxed superannuation fund’s assessable income.
Where the death benefit is paid to dependants from a superannuation fund could apply.
Superannuation death benefits paid to tax dependants
Age of Super death Age of Taxation on taxable
deceased benefit recipient component
Any age Lump sum Any age Tax-free
Aged 60 Income stream Any age Taxed element — tax-free
and over Untaxed element — marginal
tax rates with a 10%
tax offset
Below Income stream Aged 60 Taxed element — tax-free
age 60 and above Untaxed element — marginal
tax rate with 10% offset
Under age 60 Taxed element — marginal tax
rate with 15% tax offset
Untaxed element — marginal
tax rate
In contrast, if the insurance benefit is paid to non-dependants under the Tax Act, it may be paid as a lump sum and taxed accordingly. Below outlines some common situations that can occur.
Superannuation death benefits paid to tax non-dependants
Age of Super death Age of Taxation on taxable
deceased benefit recipient component
Any age Lump sum Any age Taxable element — 15% plus
Medicare levy
Untaxed element —30% plus
Medicare levy
Any age Income stream Any age Not applicable, however death
benefit in-come streams which
were commenced prior
to 1 July 2007 will be taxed as
if received by a dependant.
Where super death benefits are paid to the trustee of a deceased estate, they will be taxed in the same way as they would be if paid to the beneficiary of the estate. However, because the beneficiary will not be presently entitled to the super death benefit at that time, it won’t be included in their assessable income. This creates scope for use of a superannuation proceeds trust.
Case Study 4: Tax treatment of benefits
George is 52 years old and a teacher. He has a superannuation account balance of $200,000 and $500,000 worth of term life cover. There is no non-concessional component in his fund. George dies of a heart attack on 1 November 2010. Following this event, his wife Elaine will receive a lump sum death benefit of $700,000 tax-free.
Let’s assume that prior to his death, George divorced Elaine, and instead nominated his adult son, Jason, as his nominated beneficiary. As Jason meets no other dependency criteria, he is considered a non-tax dependant.
If the $700,000 death benefit comprises a taxed element of $420,087.61 and an untaxed element of $279,912.39, the taxation of the payment will be as follows:
Untaxed element
$279,912.39 x 31.5% (MTR) = $88,172.40
Taxed element
$420,087.61 x 16.5% = $69,314.46
Total tax paid = $69,314.46 + $88,172.40 = $157,486.86
Net death benefit = $700,000 - $157,486.86 = $542,513.14
This demonstrates that in the case of a client’s circumstances changing, advisers should reconsider whether insurance held inside superannuation is still the best option.
TPD insurance
Outside super, TPD premiums are not tax deductible to individuals, although the benefit payment is tax free if paid to the injured person or their relative. For TPD held inside super, premiums are tax deductible for the super fund.
The current practice has always been … that the TPD premium should be deductible, [however] now the Government is making it a little bit more restrictive from 1 July 2011 in that it’s only going to be deductible to the extent to cover the liabilities of the fund.
Super vs Individual: TPD Insurance Taxation
Superannuation Fund Individual
Premiums Deductible only for ‘any occupation Not deductible
definition TPD from 1 July 2011*
Proceeds Not assessable Generally not
assessable**
* From 1 July 2011, premiums funding own occupation definition of TPD will not be deductible
**Depends on relationship of individual owner to life insured - not assessable under section 118-37 of the Income Tax Assessment Act 1997 where the life insured is owner or relative of owner.
Trauma
As the Australian Taxation Office (ATO) does not allow tax deductions on premiums for trauma insurance, this is generally only found in SMSFs. However, where an individual holds the policy, the premiums are not tax deductible and the life insured generally receives the proceeds of a trauma claim tax-free.
Income protection
Income protection premiums are deductible regardless of whether the insurance is held inside or outside superannuation. However, benefit payments will be considered income and will be subject to tax.
Super versus Individual: income protection insurance taxation
Superannuation Fund Individual
Premiums Deductible Deductible
Proceeds Not assessable Assessable
(assessable to life insured)
One exception to this is where the person meets the definition of being totally and permanently disabled under ‘any occupation’ TPD, in which case, they may be eligible for a 15% tax offset.
It is important to note that income protection policies typically use the ‘own occupation’ definition, where if a client is unable to perform their ‘own occupation’ due to illness or injury and the appropriate waiting period is satisfied, then they will be entitled to the same benefit either inside or outside superannuation.
OTHER CONSIDERATIONS
Holding insurance inside super, while complex, can provide a range of advantages. However, for this to work well, clients need to ensure they have considered the impact that laws governing super may have placed on their policy.
Understanding the tax implications is half the battle.
As soon as you understand what the tax impact is on the premium or a benefit, it makes that decision on what ownership structure the insurance should be held within much, much easier.
The difference between own and any occupation TPD is a case in point.
If a client wants an any occupation definition of TPD, then clearly holding it within a superannuation fund is not going to have that same sort of effect as it would if they wanted an own occupation definition of TPD insurance. So, if that’s the case, then the idea might be to hold it outside of superannuation just in case if they do become totally and permanently disabled and they can’t satisfy the any occupation definition, they will have a benefit paid out.
Cash flow
In addition to tax, evaluating a client’s access to cash flow is essential.
For instance, while tax deductibility of super is a great way of allowing clients to pay for insurance, as the primary reason for holding insurance is to provide for dependants, restrictions on the release of payments means access to funds must be considered.
Taking an income/capital approach can make it easier to decide which option is best.
It becomes much easier to start working out whether or not a) insurance should be held, but b) what types of insurance?; and c) what are the implications that we can explain to advisers in terms of what the implications are, up until a point of claim and then post that point of claim?
For instance, clients in the accumulation stage with young children and greater living and education expenses might be more suited to holding insurance inside super due to the more affordable premiums.
They’re going to have a large mortgage, they’re going to have quite a lot of liability in that 30+ age group and at that time that’s when they’re most cash flow restricted so it’s great to fund insurance through superannuation to ease that cash flow burden, but also give them the capital that they need to fund those liabilities in the unforeseen event of TPD or death or some other incapacity event.
The following case study demonstrates how holding insurance inside super can benefit those with restricted cash flow.
Case Study 5: Maximising coverage
Melanie is 33 years old and works part-time as a nurse earning $30,000 p.a. To provide for her young child, she has found a life insurance policy with a $1,000 premium that provides her desired level of cover.
As Melanie can only afford to pay $500 towards this premium, she could consider contributing this amount into superannuation and holding insurance through her super fund. This would entitle her to a $500 government co-contribution (at current rates), which could cover the cost of her premium without reducing the $2,700 SG contributions made by her employer.
For those clients moving into the transition to retirement phase, insurance outside super may be more beneficial if they want to boost their super savings and take advantage of accelerated benefits between ages 55 and 65.
Ultimately, the decision of what type of insurance to hold comes down to the individual client.
There is no point having insurance if the benefit is not going to be paid out according to the client’s wishes, so you really need to look at what sort of insurance the client is focusing on and then make that decision as to whether or not it should be held inside or outside super.
Lump sum or pension payment?
Beneficiaries will also need to consider whether they opt to receive their payments as a lump sum or pension if they have the option. In some cases, this can depend on the trust deed although there are also tax and cash flow implications to consider.
Generally, only tax dependants are able to receive lump sum payments and these are usually tax-free, although there can be advantages to receiving in pension form, particularly in terms of maximising social security and super balance simultaneously.
Case Study 6: Lump sum versus pension payments
Sam is 57 years old and has a life insurance policy held within his superannuation fund. Sam dies unexpectedly of a heart attack, and his wife Lucy, aged 56, is entitled to a $1 million death benefit from his fund. Broadly speaking, Lucy can choose to take the payment as a lump sum, or draw the benefit as a pension.
If Lucy chose to receive the payment in a tax-free lump sum and invested these funds earning 7% p.a., she would achieve off a taxable income of $70,000 from this source. Having taken the lump sum, if Lucy decided that she wanted to invest this money back into super, the maximum concessional contribution she could invest is $50,000 per year or $450,000 under the ‘bring forward rule’.
If Lucy instead chose to draw down the death benefit as an income stream, this offers the dual advantages of tax-effective income and potentially favourable social security treatment. Given her age, Lucy would need to draw down at least 2% of the account balance (usually 4%, but halved under the pension relief rules which apply for the 2010/11 financial year) but could elect a higher figure in accordance with her income needs. As she is under age 60, Lucy’s pension would be taxable, but any capital and income received would be tax-free from age 60. Given that the payment is from a superannuation fund, Centrelink would consider part of the payment a return of capital and therefore assess a lower income for any means test applied. Lucy also retains the right to commute the pension and roll any benefits back into the accumulation phase of superannuation where eligible.
Death benefit nominations
To be certain that the insurance proceeds find their way to the right people, advisers should urge their clients to make binding death benefit nominations for their superannuation fund, where appropriate, and check the right kind of ownership policy is in place.
There are three main types of nomination that can be made for payment of a superannuation death benefit:
>> Non-binding — where this has been put in place, a trustee may consider a member’s nomination, but the trustee still has ultimate discretion over how payments from the super fund are distributed.
>> Binding nomination — where valid, this will ensure that the beneficiary is paid in accordance with the member’s instructions. It remains in effect for three years from the date of signing and must be witnessed by two independent witnesses with the percentage of benefits paid to the beneficiaries clearly specified. If the nomination does not comply, benefits are subject to trustee discretion.
>> Non-lapsing death benefit nomination — these are similar to binding nominations, although they won’t lapse and remain in effect until amended or revoked.
Where no nomination exists, payments will be left to the discretion of the super fund trustee and must be made in accordance with standard provisions of the SIS Act.
The trustee will choose how and to whom the benefits are paid, and a claim staking process may be required to identify the potential recipients.
Advisers should also check that the trust deed of the superannuation fund does not automatically make payments to the client’s estate, as this could mean dependants are not able to access benefits and they will be dealt with by the Will, with a higher tax liability potentially being incurred.
Estate planning
As fund members can also nominate their estate as the beneficiary of superannuation, they may need to draft a Will specifically to deal with insurance proceeds. This can mean that in many situations, the beneficiaries able to receive the proceeds will be limited to the dependants of the deceased where a superannuation proceeds trust is established by the Will.
Advisers should encourage their clients to consider who should receive their death benefits and whether they meet the condition of a dependant under the Tax Act.
To do this correctly, clients will need to ensure their super balances are accounted for in their Will, with contingency plans to provide cash for their dependants if they were to suddenly die.
The Will should also allow any surviving spouse to:
>> take the life insurance proceeds personally
>> take the proceeds as a beneficiary of a specially drafted trust
>> direct that the proceeds are paid to other dependants of the deceased.
The Will maker may also express a wish that if they leave dependants under the age of 18, the proceeds may be paid to a superannuation proceeds trust. This will provide concessional rates of tax on income generated by the trust and distributed to minor beneficiaries.
For self managed super funds (SMSFs), there is an even greater range of issues to consider and above all, regularly monitoring and reviewing plans is crucial.
FINAL TIPS
While there are undoubtedly advantages for holding insurance inside super, Leong said clients and advisers need to continually review their arrangements to make sure they remain relevant.
People tend to do a set and forget type strategy where they place insurance inside super and don’t remember to review.
Advisers should look at the wider picture to be able to maximise their clients’ super balance and insurance cover.
Probably the best advice I can provide to any adviser of any risk experience level would be to combine tax strategies both inside and outside of super in conjunction with your insurance strategy for the best result for the client.
Try to enhance the tax benefits to maybe gain a greater contribution into superannuation or using those tax efficiencies within superannuation and also the pension phase to really enhance the amount of premium we can possibly deliver.
Advisers should also take into account their clients level of debt, financial commitments and future purchases. A brief checklist of issues for advisers to raise with their clients might contain:
>> Eligibility to make superannuation contributions
>> Current levels of contributions caps
>> The types of insurance the client wants to hold
>> Trust deed of the super fund
>> Tax considerations
>> Ability to access benefits
>> How the fund will account for tax deductions on premiums
>> Whether to opt for lump sum or pension benefits
>> Is there a binding nomination in place?
>> Is the Will up to date?
IN CONCLUSION
While the affordability of insurance premiums inside super is attractive, advisers need to weigh the advantages against the complexities surrounding the payment of benefits and conditions of release. To decide which is best, Leong said advisers should really think about their client’s entire situation, rather than attempt to engineer the best tax outcome.
People get insurance for a reason. When someone suffers an injury, is disabled or dies, they or their beneficiaries need the insurance proceeds to continue on with their lives. Therefore, at claim time, easy access to proceeds that are not severely reduced by tax is critical. Insurance should be structured so that this is taken into account.