As part of a financial planner’s armoury, it is not uncommon to discuss the implications of holding insurance policies inside or outside superannuation.
Since the introduction of the Simpler Super reforms, holding insurance cover within superannuation has been an attractive strategy and, at the same time, we have seen the size of the self-managed superannuation fund (SMSF) market increase. So, it should come as no surprise that the discussion surrounding holding life insurance cover through superannuation has increasingly involved holding the cover through a SMSF.
Benefits
The primary benefits of holding insurance cover inside a SMSF are similar to the general benefits of holding insurance cover inside superannuation, which include the following.
Superannuation contributions made to fund premiums may attract tax concessions, depending on the individual’s circumstances. These tax concessions often help to reduce the net cost of the contributions required to fund the premiums. Further, as the SMSF trustees are generally able to claim a tax deduction for insurance premiums, taxable superannuation contributions that are used by the fund to pay premiums will generally not attract tax at fund level.
Premiums can be paid via tax effective superannuation contributions. However, they can also be paid using a member’s Superannuation Guarantee contributions, fund investment earnings, and/or accumulated member benefits. So fund members do not necessarily need to pay insurance premiums from their own hip pocket. Where premiums are funded in this way, it will impact retirement savings over the long term.
Despite these benefits, when contemplating whether an insurance policy should be held within a SMSF there are a number of factors to consider.
Importantly, the Government has indicated that the change will only take effect from 1 July 2011. In the interim, transitional legislation will be introduced to ensure that super funds will be allowed to continue their current practice of claiming full tax deductibility for TPD insurance arrangements.
It’s also important to remember that any payment of insured benefits from a superannuation fund to a member, or indeed to a member’s dependant(s) following the member’s death, will be taxed accordingly as superannuation benefits.
Depending on the circumstances, this may result in additional tax being paid by the member (if paid on the grounds of permanent incapacity), or additional tax being paid by a member’s beneficiary(s) where they are non-dependants for tax purposes following the receipt of a death benefit payment.
Where we are dealing with an income protection policy designed to provide cover for a fund member in the case of their temporary incapacity, the proceeds received will be treated as ordinary income and taxed accordingly.
While SMSFs will generally claim a tax deduction for insurance premiums paid during an income year, in the year that a death or disability benefit is paid it may be advantageous not to do so.
By making an election not to claim the premiums in the current year as a deduction, and foregoing the ability to ever again claim a tax deduction for insurance premiums in future years, a SMSF may benefit from a far more significant tax deduction that can also be carried forward into future years.
Insurance cover: $1.0 Million
Total death benefit: $2.1 Million
In the year of Jack’s death, the surviving fund trustees chose not to claim a tax deduction for the insurance premiums it has paid, and acknowledged that they will never again claim a tax deduction for future insurance premiums paid by the fund.
As a result, the fund trustees will now benefit from a tax deduction as follows:
$2.1 million x 25 years of future service
= $1.5 million
This $1.5 million tax deduction is likely to create a tax loss for the fund, which potentially can be carried forward and used in future tax year(s) to benefit the remaining fund members.
Fabian Bussoletti is a technical analyst with AMP.
