Holding buy/sell insurance in super

Not that long ago, superannuation was a minefield if you wanted to hold insurance policies within it to fund business succession.

At the time, many business owners would have been hit by the super surcharge for contributing to super and further constrained by high taxes and reasonable benefit limits on claims paid as super benefits. The general view was that super was best used for personal insurance or by the small end of town for business insurance.

However, last year’s introduction of the Better Super system created an opportunity for advisers providing advice on the funding of business succession triggers, such as death and disablement, to have another look at super.

Alarmingly, only 9 per cent of small businesses with multiple owners have buy/sell insurance in place (Cameron Research Group 2008). It is important then to provide a solution that makes the funding of business succession agreements more attractive.

Using super — cash flow and equity

As with using self-owned policies for business succession, each owner pays for their own premium via super and — if an insurance event occurs — they, or their beneficiaries, receive the insurance proceeds. The most common model is that the insurance proceeds are deemed as compensation for transfer of their interest in the business to the ongoing business owners; however, other cash flow models can be used for complex business structures or to address estate planning concerns.

Having business owners effectively paying for their own succession can be unfair if they have to pay more for their insurance due to age or health. However, adjustments to remuneration can be made to ensure the arrangement is equitable.

Business owners cross-owning policies on each other’s lives is another solution to this inequity, and logically, the proceeds will end up in the hands of the ongoing owners, who then acquire the departing owner’s business interest.

However, not only are the policy premiums on a cross-owned succession arrangement non-deductible, as with self-owned policies, the policy proceeds in the event of total and permanent disablement (TPD) and trauma will generally be subject to capital gains tax. Further, the gain will generally not be a discount gain nor will there be a cost base.

Equally, trying to hold insurance through the business or have the business fund the premiums is a minefield of fringe benefits tax, unfranked dividends or employer termination payment tax.

Super to the rescue

The benefit of holding business insurance within super is that premiums are funded by concessional contributions paid for by, and fully deductible to, the business owners’ entity or personally deductible to business partners. Once in the fund, the contributions can be utilised to purchase insurance premiums to acquire the succession insurance for which the fund will get a further deduction.

Apart from transitional arrangements, a contribution limit of $50,000 per annum will apply, with any additional contributions taxed at 31.5 per cent. However, the 15 per cent deduction the trustee gets for the premium, which for most retail funds is returned to the member’s account, means only those on the lowest marginal tax rate are behind when insuring through super — even where exceeding the concessional contribution cap. Excess concessional contributions are counted towards the non-concessional contribution cap.

Tax on benefits

While all death benefits to dependants are now tax-free, tax will apply to lump sum TPD benefits taken prior to age 60 and death benefits paid to non-dependants.

An appropriate needs analysis should identify the amount of cover the business owner requires for lump sum personal purposes, such as repayment of personal debt and medical expenses. This should allow the business owner’s ‘buy/sell’ TPD benefit to remain in super and/or be used to start a pension. Aside from not having to factor in lump sum tax, potential benefits are:

> the ability to draw a tax-free pension of over $44,200 per annum;

> tax-free investment earnings;

> increased government income support; and

> asset protection.

For those with non-dependant beneficiaries, super business succession is less compelling if they choose to use the concessional contribution cap for retirement income purposes.

What about trauma?

Trauma as a trigger event for business succession is less straightforward, especially as a business owner can return to work after only a short hiatus. It is up to the business owners to agree whether trauma is included as a succession trigger and how the policy proceeds are dealt with in the event equity is not transferred.

Trauma is often best left outside super, though there are a few insurers that can connect a self-owned trauma policy to super-owned life and TPD cover at extension rates. As always, research is imperative.

Jon de Fries is the manager, insurance strategy, for MLC’s Risk Specialist Network.