SMSF trustees need to comply with superannuation law, this includes the need to consider if the fund should hold life insurance on behalf of members of the fund. The insurance must align to one of the following conditions of release:
- Terminal medical condition
- Permanent incapacity
- Temporary incapacity
This can be a challenging requirement for trustees. There are many issues to consider, and typically trustees are not insurance experts. For this reason it may be wise to seek the advice of a qualified financial adviser. Below are some of the considerations that can help trustees meet their obligations.
Types of cover
There are three types of insurance cover which align to the superannuation conditions of release. This means SMSFs can only apply for the follow types of life insurance:
Life insurance can cover you in the event of death or if you are terminally ill. Holding life cover via your SMSF means the terminal illness definition must align to being unlikely to live beyond 24 months.3
Total and Permanent Disablement (TPD) insurance will cover you if you are unlikely to ever be gainfully employed due ill health.
Each insurer will have unique definitions and features depending on the policy, but one of the key features is the occupation type. There are two occupation types for TPD cover, ‘Any Occupation’ and ‘Own Occupation’. Own occupation tends to be specific to your role, and can mean a benefit payment if you are unable to work in your role. ‘Any Occupation’ means you are unlikely to receive a benefit payment unless you cannot work in any gainful occupation you are reasonably suited for.
But to pay a benefit from an SMSF the trustees must be satisfied that, due to ill‑health, you are unlikely to engage in gainful employment for which you are reasonably qualified by education, training or experience.3 So SMSFs are limited to holding an eligible ‘Any Occupation’ TPD cover within the fund.
Income Protection insurance will cover you if you temporarily stop working due to ill health. Income protection will have both a waiting period and a benefit period. The waiting period is the amount of time you are unable to work due to ill health before you receive benefits. The benefit period is how long benefits will be paid once you are eligible.
SMSFs rely on the temporary incapacity condition of release to pay out income protection benefits. This condition of release only allows for an income stream no more than your income prior to being unable to work. In addition, you cannot use your superannuation balance to pay the income stream. In other words, this condition of release will generally only allow for benefits to be paid if there is an income protection policy in your SMSF.4
Inside vs outside of super
Once you know the type of cover you need, you then need to determine how to hold the insurance. This can be difficult as there are different outcomes inside super compared to outside super. The key points to consider are:
SMSFs can generally claim a tax deduction for the premiums they pay.5 This can reduce the real cost of the insurance. In comparison, individuals are unlikely to be able to claim a deduction for life insurance and TPD insurance.
Individuals may be able to claim a tax deduction for Income Protection Cover. So your marginal tax rate and ability to make extra concessional contributions are key considerations when determining suitability of holding this cover in your SMSF.
Taxation of benefits
Life and TPD benefits received personally are generally received tax free.6
In comparison, TPD benefits received via super may have tax consequences. Life insurance benefits paid via super will have different tax implications depending on how they are paid and to who. Lump sums paid to a non tax-dependent may have tax implications7, if life insurance benefits are paid as an income stream then tax implications will vary depending on the age of the deceased and the age of the beneficiary.
Income Protection benefits are generally taxable regardless of how they are received.
Who will receive the benefits?
Life insurance held personally can generally be paid to anyone. Whereas Life insurance held via the SMSF can generally only be paid to eligible dependants, or the member’s legal personal representative. This can be a key consideration for blended families and people whose beneficiaries are not superannuation dependants.
Impact on your balance
Insurance can be costly and may get more expensive as you age. This combined with a lower concessional contributions cap may cause the insurance to have a negative impact on your SMSF balance. Making non-concessional contributions or holding cover personally may help reduce this impact.
Insurance held inside an SMSF is generally more restrictive than insurance held personally. Holding cover personally may be a good idea if you have a unique occupation, or want policy features which do not align to a condition of release.
Levels of cover
Once you have decided how to hold insurance, the next step is determining your level of cover.
Unlike some APRA regulated super funds, SMSFs don’t have a mandatory basic level of insurance. So it’s up to the trustees and members to determine their own level of cover.
Levels of cover involve a wide range of considerations unique to your circumstances. Some of the considerations are:
- Do you want to keep the lifestyle you currently have or are you willing to make changes if something were to happen?
- Do you have assets that you could sell or use for income if you are unable to work, and would you want to sell those assets?
- Are there liabilities that you would want to repay to reduce stress, or would you be happy to keep the liabilities?
- If you have dependants and how long you expect them being dependants?
- How much will you need for expenses such as medical services, altering living arrangements or extra support?
- Insurance covers can overlap if you have two covers of the same type, or have different insurances covering the same event. Should you adjust your other insurance covers to avoid being over insured?
Once you answer these questions you should get sense of how much you would need if you were unable to work or die. From these you can start to assess if there is a gap between what you have and what you need.
Once you have made the decisions about the types of cover you need, which types should be held outside vs inside your SMSF, and how much you should be covered for, the next step is finding a policy that will be suitable for your needs.
This can be very complicated and difficult to get right. As such it's a good idea to speak with a qualified adviser to discuss your options. They can help work out the level of cover you need and recommend a suitable policy for you.
1This requirement does not apply to some life insurance policies put in place prior to 1 July 2014.
6There are certain situations where personally held Life and TPD policies may be subject to tax such as where there has been a change in policy owner or in business insurance situations. You should clarify always clarify with a tax adviser about the tax implications of your particular circumstances.