Commercial property and SMSFs: insurance considerations
It is common for businesses to have a buy/sell agreement in place, in case a director or owner dies or becomes incapacitated.
The agreement is an insurance contract, which allows the remaining directors to buy out the deceased partner’s interest in the business. This allows the business to continue operating, with the proceeds from the insurance payout used to compensate the deceased director’s beneficiaries.
But often, while this arrangement is in place for the business itself, no such arrangement exists for the company’s business premises, which can be held inside a self-managed super fund (SMSF). Often, the directors of the business establish an SMSF for the sole purpose of holding the commercial property where the business is located inside it.
So it’s important for SMSF members and business owners to consider how insurance might be used to protect this asset, in case one of the business owners dies.
Peter Hogan, the Self-Managed Super Fund Association’s head of technical, says this has become a consideration as limited-recourse borrowing arrangements have become an popular way for SMSFs to hold property inside the fund.
To safeguard the property for the business in the event of the death of a director, he says SMSF trustees can write an insurance policy over the lives of the members. This allows the trustees to pay a benefit to the deceased’s beneficiaries, so the trustees are not in a position of having to sell the property to fund the benefit. The key decision is whether the policy should be held inside or outside the fund.
“The ATO takes the view that when trustees own insurance policies inside the fund, any proceeds from a payout after an insurable event must be credited to the insured member’s account,” says Hogan.
Before 1 July 2014, trustees could use their discretion, if the trust deed allowed, as to which member received the proceeds of any insurance payout. This meant that, for instance, if the fund’s members were both parents and children, in the event a parent died, the trustees could contribute the proceeds from the payout to the child or children’s account.
“Now insurance proceeds must be credited to the insurance policyholder’s account. This has changed the way trustees allocate proceeds,” advises Hogan.
What this means for SMSF investors with a commercial property inside their structure is that in these circumstances it makes more sense for any insurance agreement to be held outside the SMSF.
In the event one of the directors dies, holding the insurance policy outside the fund will allow the SMSF trustees to pay out the beneficiaries, rather than having to contribute any proceeds from the payout to the deceased member’s account.
This reduces the risk of the beneficiaries taking control of the commercial property after the death of one of the directors of the business.
It’s worth noting, however, that any arrangements related to insurance inside or outside superannuation made before 1 July 2014 are grandfathered. So in the event an SMSF holds an insurance policy inside the fund it’s likely the ATO would allow trustees to exercise their discretion over how any payout should be paid.
However, the SMSF community would welcome further clarification around this from the ATO.
Additional insurance considerations
The roles around insurance inside SMSFs changed substantially on 1 July 2014. From that date the insurances that could be held inside an SMSF were life insurance, any occupation total and permanent disability insurance and income protection. Own occupation insurance and trauma insurance must be held outside super.
Provisions have been grandfathered so own occupation policies and trauma insurance bought prior to 1 July 2014 can still remain inside an SMSF.
Often, insurance companies will offer linked policies, and allow SMSF members to hold any occupation TPD insurance inside super and own occupation TPD insurance outside super. This gives fund members flexibility in the event the policy is triggered.
The rules around SMSFs and insurance are complex. It’s important to ensure you understand how the insurances you hold work, and make sure the policies meet the requirements of the SIS Act.
It’s worth seeking expert advice if you are at all unsure of how to hold insurance inside or outside your SMSF.