Are you benefiting from insurance in super?
Holding insurance inside superannuation can be very tax effective – primarily due to the various concessions available when making superannuation contributions.
Holding insurance cover inside superannuation has been a popular solution for many clients and a default position for many of those in employer or corporate super plans. However, there are a number of factors that should be considered when holding insurance cover inside superannuation.
In this article, we take a look at some of the benefits and key considerations of holding the two most common types of insurance cover within the superannuation environment – that is, life and total and permanent disability (TPD) cover.
Benefits of holding insurance in superannuation
One of the advantages of holding insurance in superannuation is the ability to use various funding methods to meet the cost of the premiums. Depending on the client’s situation, the premiums can be funded using:
- pre-tax (salary sacrifice or personal deductible) contributions
- after-tax contributions, or
- accumulated superannuation savings.
As a result, holding insurance inside superannuation can be very tax effective – primarily due to the various concessions available when making superannuation contributions.
Further, because the trustee can generally claim a tax deduction for insurance premiums, any taxable contributions made to the fund, that are then used to pay premiums, effectively do not attract contributions tax.
Trustees can generally claim 100% of the insurance premiums as a tax deduction for term life, certain TPD policies, and income protection policies.
TPD insurance premiums are only deductible to the extent that the policy relates to the fund’s liability to provide permanent incapacity benefits. Broadly, this means TPD insurance premiums will only be deductible to a superannuation fund to the extent that the policies are attributable to the fund’s liability to provide ‘any occupation’ permanent incapacity benefits.
Alternatively, premiums can be paid using the individual’s accumulated superannuation benefits – meaning that the member will not need to pay insurance premiums from their own pocket. However, funding premiums in this way may erode retirement savings over the long term.
Note: Contributions made to fund insurance premiums will continue to count towards the member’s relevant contribution caps.
Other potential advantages include:
- Cheaper premiums: Potentially in larger funds because of economies of scale.
- Automatic underwriting: Some funds may offer group plans with automatic underwriting. This will be attractive for individuals who have pre-existing medical conditions and who would otherwise not be able to obtain the required level of cover.
There are also some potential pitfalls of holding insurance within super that may only become evident at the time of claim. The reminder of this article looks at the key considerations to be factored in before recommending life and/or TPD cover be held inside super.
Life cover within superannuation
Unlike insurance policies held outside of super, superannuation death benefits (including life insurance proceeds) can typically only be paid directly from the superannuation fund to someone who is either their superannuation dependant or legal personal representative i.e. their estate.
The tax treatment of a lump-sum superannuation death benefit depends on whether:
- the recipient is a dependant or a non-dependant for tax purposes, and
- the form of the death benefit (ie lump sum or income stream).
A dependant (for tax purposes) will receive a superannuation lump sum death benefit tax-free, irrespective of the underlying tax components.
Non-dependants (for tax purposes) will pay tax on the lump sum death benefits, as per the table below:
Note: Where a superannuation trustee has been claiming a tax deduction for the cost of the insurance premiums, life insurance held within superannuation creates an untaxed element when the death benefit is paid as a lump sum.
It should also be noted that death benefits may also be paid in the form of a death benefit pension to a limited range of beneficiaries e.g. to a surviving spouse.
Where the death benefit is paid in the form of an income stream, the tax treatment of the income stream payments depends on the age of the deceased and/or the age of the beneficiary as outlined below:
Total and permanent disability
The insurance claim and the condition of release
Whilst new “own occupation” TPD policies are no longer available from 1 July 2014, superannuation funds may still hold grandfathered TPD “own occupation” policies for members.
As such, in some situations, a member might meet the insurer’s definition of disability (potentially under an ‘own occupation’ definition), resulting in the proceeds being paid to the fund trustee. However, unless the narrower SIS definition of permanent incapacity is also satisfied, the superannuation benefits will remain preserved.
The permanent incapacity condition of release requires that the trustee is reasonably satisfied that the member is unlikely, because of the ill-health, ever again to engage in gainful employment for which the member is reasonably qualified by education, training or experience.
This will not be the case if the member has met a different condition of release e.g. the member has reached preservation age and retired, or is age 65 or older.
Taxation of TPD benefits
It is a common misconception that TPD insurance held within superannuation can be paid tax-free to the member following the release of the benefit on the grounds of permanent incapacity. However, the tax payable (if any) will depend on:
- the age of the member at the time the benefits are received,
- whether they are paid from a taxed or untaxed fund, and
- whether the benefit is taken as a lump sum or an income stream.
Upon withdrawal, the taxable component (paid from a taxed superannuation fund) will be subject to tax as follows:
Note: Under the proportioning rules, tax-free component cannot be taken out separately from taxable component. Each withdrawal will contain both tax-free and taxable components in proportion to the overall account balance.
While a lump sum benefit is unlikely to be completely tax-free, an increased tax-free amount (in addition to any tax-free component the member already has in the superannuation fund) may be available if the payment qualifies as a disability superannuation benefit.
The tax-free component of a disability superannuation benefit will be increased to broadly reflect the period where the person would have expected to have been gainfully employed. As such, it is worthwhile considering the points below when recommending TPD insurance within superannuation:
- The closer the member is to age 65 when they stop being capable of gainful employment, the lower the tax-free portion of their payment. This is because they have less time until they would have otherwise been deemed to retire (usually age 65).
- A longer service period also results in a lower tax-free portion. It can therefore be more tax effective to place TPD insurance in a fund with a shorter service date.
- An increase in the tax-free component due to disability can only be calculated upon the crystallisation of a superannuation benefit. The crystallisation of the superannuation benefit occurs when:
- the payment is taken as a cash lump sum or
- the amount is rolled over to a different fund.
Instead of taking benefits as a lump sum, TPD benefits can usually also be taken as an income stream. Whether this is an appropriate solution for a particular client will depend on their personal circumstances at the time.
Where such an income stream is classified as a disability superannuation pension, for people under age 60, the taxable portion of the income payments will be subject to a 15% tax offset. Of course, for people aged 60 and over, the income stream from a taxed fund will be received completely tax-free.
Further, the investment earnings derived within these pension accounts will be exempt from tax, regardless of the client’s age.
So, particularly for clients under age 60, the ability to take TPD benefits in the form of afffn income stream (where it is appropriate to their circumstances) may provide certain clients with a more tax effective solution.
Note: Commencing an income stream within the same fund will not automatically give rise to an increased tax-free component (discussed earlier).
About the author
Fabian Bussoletti (FPA) is the technical services manager at AMP Advice.