Structuring insurance inside SMSFs

Recommending insurance in a self-managed super fund can be a complicated process. Troy Smith explores the factors involved in placing insurance in a SMSF and answers some of the questions associated with this process.

Recommending insurance in a self-managed super fund (SMSF) can be daunting for those who are dipping their toes in and recommending it for the first time. For those who are a little more experienced – what strategies are available?

Understanding the basics is a great place to begin, so let’s review a few key points.

Policy ownership

Placing insurance in a SMSF involves the super fund owning the policy, where the trustees of the super fund are recorded as the policy owners. As an example, the owner of the policy could be Klaus, and Heidi Pfeiffer as trustee for the Sitges Super Fund.

Notate minutes of the decision to take out insurance

Trustees of a SMSF should minute the decision to take out insurance on the life of a member and the purpose of the policy. It is often assumed that insurance can be paid directly to a member’s account.

However, if the fund rules allow, a SMSF may permit insurance proceeds to be paid either to a member’s account, added to the accounting income of the fund or credited to the reserves of the fund. Whatever the decision, the outcome should be suitably recorded.

Insurance payment

The proceeds of an insurance claim are usually required to be paid to the super fund as owners of the policy. At no stage, is it advisable to pay the proceeds of the insurance policy directly to the life insured or other members of the super fund.

This is consistent with one of the most basic rules of a SMSF that all benefits paid must satisfy a condition of release and be consistent with the provisions of the fund’s trust deed. In cases such as payouts due to disability or trauma, a condition of release may not be satisfied.

Paying a benefit

Once a super fund has received the proceeds of an insurance payout, the trustees must decide how it is to be dealt with under the provisions of the fund’s governing rules and whether a condition of release has been met. If a condition of release is not able to be met, the proceeds of the insurance policy must remain in the super fund. If a condition of release is met, the trust deed will indicate how the benefit can be paid as a lump sum, income stream, or a combination of the two.

There are a number of frequently asked questions about SMSFs and investing in insurance policies. Here are some of them:

Is a nominated beneficiary required to be recorded on the insurance policy?

No. As the proceeds are paid to the super fund, the trustees of the super fund are responsible for paying a benefit to either a member or a beneficiary. 

In the case of a life insurance policy that paid out upon death of the life insured, the proceeds are paid to the super fund, and the trustees may pay a death benefit (death is a condition of release). The trustees may pay a death benefit as required under any death benefit nomination of the deceased, and subject to the rules of the fund. 

Can a policy be transferred into a SMSF?

SMSFs are generally prohibited from acquiring an asset from a related party. Therefore, it is not possible to acquire an insurance policy from a fund member or relative of a fund member.

A practice adopted by many insurers is that an existing policy is cancelled and a new policy issued with the SMSF as the owner. Advisers should consider whether the new policy has different terms and conditions compared to the old policy, and consider if underwriting is required.

Can a SMSF own trauma insurance over a member?

Trustees of a SMSF can hold trauma cover within the fund. This position was clarified by the ATO in SMSFD 2010/1.

However, there are some traps for new players:

• A super fund can not claim a tax deduction for trauma insurance premiums.
• The occurrence of a trauma event to the life insured usually does not result in a condition of release being met. 

If a condition of release is not met, a super fund member must generally wait until preservation age before accessing the benefit (such as the retirement). While this may have a number of difficulties if the member requires the benefit to pay bills, it can remain in the fund until a further condition of release has been met.

Case study 1

Joan (52) has an insurance policy which includes trauma cover inside her SMSF. She has a stroke, which triggers a $50,000 trauma payment to her SMSF. Joan is temporarily unable to work, but will return to work after a recovery period of eight weeks. Unfortunately, Joan doesn’t meet a condition of release, and is unable to access her super until a subsequent condition of release is met.

Case study 2

Jacky (63) also has an insurance policy which includes trauma cover inside her SMSF. Jacky is diagnosed with multiple sclerosis, which triggers a $60,000 trauma payment to her SMSF. She decides to retire and ceases an employment arrangement, which means she meets the retirement condition of release. Jacky is able to access her super. 

Deciding whether or not to claim a tax deduction

One strategy which can be overlooked, is to consider whether the super fund should elect or reject claiming a tax deduction for the death and disability component of an insurance premium.

Generally, super funds can choose to claim a tax deduction for insurance premiums. Where the trustees of the fund decide not to claim a deduction for the premiums, a deduction may be available to the fund for the future liability to pay death and disability benefits. This is available from the time the member’s death or disability benefit has been paid. It may provide a greater tax benefit to the fund than claiming a tax deduction for death and disability premiums on a year by year basis.

Summary

Structuring insurance inside a SMSF provides an opportunity to take advantage of the flexibility offered by SMSFs. Understanding the basics is necessary in order to provide a solid foundation to build strategy. Advisers who understand the strategy have the potential to strengthen their relationship with their SMSF clients and provide some tangible benefits.

Troy Smith is the technical services manager at OnePath.