Martin Breckon outlines the forthcoming changes to TPD insurance in superannuation, including recent amendments to simplify the way funds can determine the deductible premium portion.
On 30 June this year, transitional relief that has enabled super funds to claim a full deduction for premiums on insurance policies with a range of total and permanent disablement (TPD) definitions will cease.
From 1 July, super funds will only be able to claim a full deduction for TPD premiums where there is a liability to provide a ‘disability superannuation benefit’ as defined in paragraph 295-460(b) of the Income Tax Assessment Act (ITAA) 1997.
Broadly, this definition requires that two medical practitioners certify that, because of ill health (physical or mental) it is unlikely the person can ever be gainfully employed in a capacity for which they are reasonably qualified because of education, experience or training.
The Australian Taxation Office also stated in draft taxation ruling TR 2010/D9 that in order to provide a disability superannuation benefit, the relevant condition of release that must be met is ‘permanent incapacity’.
Implications for own occupation TPD policies
It is broadly accepted that the any occupation TPD definition is based on the same conditions required to establish permanent incapacity.
Where this is the case, the super fund should meet the disability superannuation benefit definition and, therefore, should generally be able to continue to claim a full deduction for the TPD premiums.
Implications for other TPD definitions
If the trustee is uncertain whether the fund will always be able to meet the disability superannuation benefit definition, it will be necessary to determine the deductible and non-deductible portion of the premiums.
This will generally be the case where the TPD policy has an own occupation definition.
This is because, in some situations, while a fund member may not be able to perform his or her own occupation, they may fail to meet the disability superannuation benefit definition because they are able to be gainfully employed in a capacity for which they are reasonably qualified because of education, experience or training.
It may also be necessary to determine the deductible and non-deductible premium portions where the policy contains other broader TPD definitions, particularly if a specific amount is included in the premium for these definitions.
Apportioning the premiums
The Government has stated that where broader TPD insurance cover is provided, super funds must obtain an actuary's certificate to determine the deductible portion of the premium, unless that portion is specified in the insurance policy.
However, on 26 May 2011, the Government announced that legislation has been introduced that will streamline the way super funds calculate the deductible portion where broader TPD insurance is provided. These amendments:
- Allow the percentage of certain TPD insurance premiums that can be claimed as a deduction to be specified in regulations; and
- Will give many super funds the option of using a simpler method to determine the deductible portion without having to engage an actuary.
The percentages to be prescribed in regulations will be finalised following consultation with industry.
Cost implications
Additional tax may be payable where the super fund is not able to claim a full deduction for own occupation (or other) TPD policies. Where this results in an additional cost to the members, it is anticipated that holding these policies in super will generally still be cheaper than insuring outside super, as the case study below illustrates.
This is because the cost increase is likely to be relatively small and it will still be possible to benefit from some tax concessions generally not available when insuring outside super.
For example, assuming certain conditions are met, fund members may be able to claim super contributions as a tax deduction or make pre-tax salary sacrifice contributions.
Case study
David, aged 42, pays tax at a marginal rate of 38.5 per cent (including a Medicare Levy of 1.5 per cent) and has a Self Managed Superannuation Fund (SMSF).
He wants to take out a Life and own occupation TPD policy with a sum insured of $1 million. The premium is $2,000 in year one, comprising $800 for the Life Cover and $1,200 for the own occupation TPD policy.
If David purchases this insurance in his own name (outside super), the pre-tax cost will be $3,252, after taking into account the tax he would have to pay on his salary.
Under the current (pre-1 July 2011) rules, his SMSF will be able to claim a deduction for the total premium and the deduction could offset the 15 per cent contributions tax payable if he makes salary sacrifice contributions to fund the premiums. As a result, the pre-tax cost of insuring in super will be $2,000.
Let’s now assume, for illustrative purposes, that the Government specifies in regulations that the percentage that can be applied to determine the non-deductible portion of own occupation TPD policies from 1 July 2011 is 33 per cent.
In this example:
- The non-deductible portion of the TPD premium will be $396
- 15 per cent contributions tax (ie, $60) will be payable in the fund on this amount; and
- He chooses to increase his salary sacrifice contributions by $70 to make a provision for the contributions tax.
As a result, under the new rules, the total pre-tax cost will increase from $2,000 to $2,070. So taking out the cover in super will still be considerably cheaper for David than insuring outside super.
Other issues
- It is anticipated that under the new rules, insuring in super will still generally be cheaper than holding the cover outside super if the sum insured is grossed up to make a provision for lump sum tax.
- There is a risk (albeit historically small) that the super fund may not be able to release an own occupation TPD benefit under the permanent incapacity condition of release.
- Provided the permanent incapacity (or other) condition of release is met, the benefit can be received as a tax-effective pension. Alternatively, the money could be kept in the accumulation phase, where it won’t be counted towards the social security income and assets test until the member reaches age pension age.
Martin Breckon is a senior technical consultant with MLC Technical Services.
