Insurance

The SMSF Institute - Insurance through your SMSF

In recent years it has become increasingly common for the insurance needs of an individual to be met through their superannuation fund. And, while there are a number of reasons why superannuation and insurance go hand in hand, when considering an SMSF as your retirement vehicle of choice, there are additional benefits only available to SMSFs.

 

Holding insurance through an SMSF has proven popular predominantly because it is often cheaper to hold the cover and pay for premiums through the fund.
However, before discussing the advantages of holding insurance through your SMSF, it's important to understand a few basic concepts which are best explained through a diagram:

Self Managed Super Fund - Insurance

* Requires a suitable superannuation condition of release to be met e.g. death or disability.

 

Why hold insurance through superannuation?

There are 2 primary reasons why insurance is often held through a superannuation fund.

1. Cash flow

Where you personally have insufficient money to pay for insurance premiums from your after-tax income, having premiums paid by the fund can help. Because the insurance policy will be owned by your SMSF, it is your fund that will pay the premiums using money that it already holds. Similarly, if you have your employer's compulsory superannuation contributions going into your fund, these amounts can be used – without impacting on your hip-pocket.


2. Tax effectiveness

In order for an SMSF to make its premium payments without impacting on its member's retirement nest-egg, members often increase their contribution levels to the fund. Because these contributions are generally tax deductible, or attract some other form of tax concession, it makes the after-tax cost of the insurance premiums more affordable. Effectively, it's a way of getting the Government to pay for part of your insurance premium.

For example, let's assume that your annual insurance premium is $5,000. If you are on the 46.5% marginal tax rate, and own this insurance policy in your own name, you will have to pay the premium using after-tax income. Instead, by holding the cover through your SMSF and making tax-deductible contributions into the fund in order for the SMSF to make premium payments, this same insurance cover will effectively only cost you $2,675. Similarly, if you are on the 38.5% tax rate the cost reduces to $3,075. So, whichever way you look at it, holding the insurance cover through your SMSF represents a significant saving.

 

SMSF only advantages

In addition to the advantages noted above, there are a number of additional benefits to holding insurance through superannuation when you have your own SMSF

Tax deductibility of premiums

In addition to the tax concessions that may be available with respect to any contributions made into the fund, all superannuation funds are generally able to claim insurance premiums as a tax deduction for the fund (refer to table below). This tax deduction is useful in reducing the tax payable on taxable member and employer contributions, or other fund investment earnings.
As an alternative to claiming insurance premiums as a tax deduction each year, an SMSF has the special ability to claim a different type of one-off tax deduction – which is not practically available in other types of superannuation funds.

By applying a special formula in the year that a death or disability benefit is paid from the fund, this tax deduction can produce some significant tax benefits for the SMSF and its members.

Example:
Consider Mark, a 50 year old who has an SMSF and \a superannuation membership period of 25 years. He becomes disabled and receives a disability benefit of $1.5 million from his SMSF which includes $500,000 of life insurance.

In addition to having received the benefits of a tax deduction for insurance premiums paid by the fund each year, the SMSF will now also be entitled to a tax deduction of over $560,000.

This tax deduction can be used by the fund to reduce the tax it is required to pay on capital gains, investment earnings such as rent and dividends, as well as taxable contributions it receives.

Meeting fund liabilities

As the prevalence of borrowing inside SMSFs increases, a fund's ability to meet its loan repayments is becoming a far more significant consideration.
Quite often, your SMSFs ability to meet its loan repayments will be reliant on your ongoing ability to make regular contributions into it.

So if you were to die or become permanently disabled and your ability to continue contributing become restricted, having an insurance policy owned by your fund – set up for the specific purpose of repaying this loan – becomes a critical consideration in order to avoid a forced sale of the asset. Particularly where the SMSF loan relates to a property that you use in your own business!

Maximum income protection

In general, income protection (or income replacement) policies will generally replace up to 75% of your pre-disability income should you be unable to work due to a temporary illness or injury.

However, by carefully applying following the superannuation rules – and combining them with an appropriately structured income protection policy owned through your SMSF – it is quite possible for you to be able to cover up to 100% of your pre-disability income.

July 2014 rule changes

From 1 July 2014, the superannuation law prohibits the trustee of an SMSF from providing an insured benefit in relation to a member unless the insured event is consistent with a condition of release such as death (including terminal medical condition, permanent incapacity or on temporary incapacity.

This means that the trustee of an SMSF would not be allowed to acquire any trauma or “own” occupation TPD policies since they are not aligned with the afore-stated conditions of release. Additionally, care will need to be taken when any Total & Permanent Disablement policy or Income Protection policy is to be acquired by the fund trustee.

It is important to note however that these restrictions do not apply to continuing SMSF owned policies already in place as at 30 June 2014.
The rules also permit variations to this cover as appropriate.   

What else do I need to know?

While holding insurance through an SMSF creates a number of advantages, it is important to remember that any proceeds following a successful claim will be paid into the SMSF and not directly to you or your beneficiaries. This has a number of implications:

Ability to release benefits

In order to take the policy proceeds from your SMSF, a superannuation condition of release will need to be met. In some cases, such as death or permanent incapacity, and temporary disability, this may be a mere formality.
However, in some cases, where a condition of release cannot clearly be satisfied, this could result in insurance proceeds being stuck in the fund. Depending on your reason for holding the insurance inside your SMSF, this is likely to create problems for you or your business.


Tax on benefits

Further, once a condition of release has been met, depending on the reason for the payment and depending on who is receiving the payment, there may be further tax consequences to consider.

For example, a death benefit that is paid to your spouse as a lump sum will be completely tax-free (with or without insurance proceeds). Yet the same proceeds paid to an independent adult child of yours are likely to attract tax – potentially as high as 31.5%.

Such tax consequences need to be carefully considered prior to deciding to hold insurance cover through an SMSF as they could unwind any of the tax benefits enjoyed within the fund.

Careful planning is required before taking out insurance through an SMSF to ensure that the opportunities that present themselves are maximised, while at the same time the potential pitfalls are carefully avoided.

 

Tax deductibility of premiums

Depending on the type of insurance policy held, the SMSF trustee can claim the following tax deductions for any insurance policies held for the members:

Insurance policy

Tax deductible portion

Whole of life

30% of premium

Endowment

10% of premium

Income protection under temporary disability condition of release

100% of premium

Total & Permanent Disablement (“any” occupation) 100% of premium
Total & Permanent Disablement (own occupation) 67-80% of premium depending on bundling and exclusions
Trauma and any other insurances No deductions available

 

Note – A tax deduction may also not be available to a fund trustee for purposes other than to provide permitted death or disability benefits, such as to provide liquidity to pay a member’s benefits without having to sell assets or to extinguish an LRBA loan.