SMSF trustees and advisers must review requirements of the treatment of insurance within their funds annually, particularly given the changes around the Superannuation Industry (Supervision) Act 1993, Janine Copelin writes.
Changes introduced to the Superannuation Industry (Supervision) Act 1993 (SIS Act) have made it even more important for trustees of self-managed superannuation funds to review portfolio and risk requirements annually.
Central to these are requirements of the treatment of insurance, which, if not adhered to, would see funds non-compliant and facing fines. These rules prohibit trustees providing insured benefits which don’t pay claims in line with the SIS Regulations, which means from 1 July 2014, insurance inside super needs to be consistent with super offered under condition of release rules, in addition to the Corporations Act 2001.
The changes, too, are not to be looked at in isolation as they impact the types of holdings including life cover, total and permanent disablement (TPD), and income protection. Hence, without proper annual review of the fund’s insurance plan to ensure it is adequately structured in line with legislation, the trustee runs the risk of being in breach.
For some clients, more often than not, insurance can be a set-and-forget strategy — except when it comes to SMSFs. From 1 July 2014, an SMSF can only be permitted to provide members with insured benefits that can be accessed on death, terminal medical condition, permanent incapacity and temporary incapacity (as defined in the SIS Regulations 1994). Note, if the trustee does not amend the fund’s trust deed, the new law will override the deed.
That said, although structuring insurance policies and paying premiums within an SMSF can be a complex undertaking, depending on the circumstances, it may suit some clients.
While there are other considerations that can have a bearing on whether or not to hold insurance inside super — such as the cash-flow appeal of paying premiums out of super which keeps money in the client’s pocket, this needs to be balanced with the fact that insurance premiums will reduce the growth of the SMSF.
This is especially the case where premiums are high due to large sum insured, age or health. High premiums could also be due to existing policies being on stepped premiums rather than level in later years. If the policies are not reviewed regularly then the premiums may rise unexpectedly.
Types of insurance
An SMSF may hold a variety of insurance policies depending on the client’s circumstance and needs. These include:
- Life insurance (or death cover): A lump sum is paid to an SMSF following the death of the insured member. Such policies may also provide for payment of benefits on diagnosis of terminal illness.
- Trauma insurance: A lump sum is paid to the fund if the member has a serious medical condition (for example, a heart attack). Importantly, the trauma insurance should have been purchased prior to the new rules which took effect from 1 July 2014. If purchased prior, strict conditions of release should be adhered to, which include satisfying ‘conditions of release’ requirements for the fund. In other words, they can continue to hold a trauma policy, but if the claim does not meet a condition of release, then the insurance payout may remain trapped inside the SMSF until a condition of release can be satisfied.
- TPD: Payment of a lump sum to the SMSF if the member is totally or permanently disabled through illness or injury.
Subject to the policy, TPD pays out if the member is unable to ever work again in ‘any’ occupation. There are two major types of TPD definitions. One is any occupation and the other is own occupation.
Own occupation has stricter definitions of what work is able to be performed. As a result, generally speaking, it is a lot easier to claim under own occupation than any occupation. The issue with superannuation is that post the 1 July 2014 changes, members are only able to purchase any occupation and not own occupation definition policies inside super.
Where a client wants to take advantage of having an own occupation rather than any occupation policy, then it can be structured so that the any occupation part of the policy is owned by the SMSF, and the own occupation part of the policy is owned and paid for by the member outside of the SMSF.
The policies, however, are linked. Accordingly, salary continuance (income protection) or payment of a predetermined amount of salary to the member’s fund may be claimed in the event they are temporarily unable to work due to physical or mental ill health.
Importantly, under revised rules, insurance, including that held within an SMSF, must meet ‘conditions of release’ terms as defined by SIS regulations. This is why trauma, own occupation TPD, and the extras on income protection policies can no longer be implemented inside super.
If an SMSF receives insurance proceeds due to an insured event occurring, a ‘condition of release’ must then be satisfied before the member can access the proceeds. There are essentially three conditions under which people normally access their super. The person:
- Has reached their preservation age and is retired; or
- Has reached their preservation age and, is still working and starts a transition to retirement income stream, where they can access up to 10 per cent of their balance per annum.
Conditions of release
Further, the conditions of release allowing for insurance proceeds to be accessed are as follows:
- Death;
- Permanent incapacity;
- Temporary incapacity; and
- Terminal medical condition
It’s important to be mindful when discussing conditions of release that each has a ‘nil’ cashing restriction, excluding temporary incapacity, which may only be accessed as a non-commutable income stream in the event it comes under requirements pursuant to SIS regulations.
Further, when such conditions of release apply, a member is prohibited from accessing trauma insurance and TPD (own occupation) proceeds from an SMSF, unless an alternative condition of release has been met.
Consequently, insurance proceeds are unable to be paid out to members at the time of their disability and alternatively are to stay in the fund until such time as an appropriate condition of release, such as retirement, has been met.
Finally there is a general lack of knowledge amongst SMSF clients on the operation of life insurance provisions and premium deductibility and claim proceeds which presents an enormous opportunity for advisers to educate and influence clients on using effective strategies in this important area.
Janine Copelin is the managing director of retail banking at Citibank.
