Tax strategies and superannuation

The lead-up to financial year end is usually seen as a time of opportunity for financial advisers to revise tax strategies with their clients. Jeff Scott explains why it is worth remembering that tax deductions are available for income protection premiums, both inside and outside of superannuation.

Traditionally, income protection policies were individually owned outside of superannuation. Since

1 July 2007, when Reasonable Benefit Limits (RBLs) were removed from super, there has been an increase in people taking life insurance through their super; and while term insurance (death cover) and total and permanent disablement (TPD) have been staples of many super funds, more people are now also placing their income protection cover within superannuation.

In addition to this trend, there remains a significant opportunity for advisers to address the income protection needs of their clients, and highlight the related tax benefits.

New research conducted for CommInsure has found that while 94 per cent of Australian workers have heard of income protection insurance, only 28 per cent have this cover.

And what’s more, 57 per cent are not aware that income protection premiums are tax deductible.

Your clients will be pleased to know that an individual who pays for the premiums with concessional contributions to superannuation, and a person who pays for income protection premiums outside super, are both entitled to a tax deduction – the main difference is that the concessional contribution to super is capped ($25,000 for those under age 50 and $50,000 for those 50 and over for the 2010-2011 financial year), whereas there is no cap on the premiums paid outside super.

It is important to know that individuals who pay for premiums with non-concessional contributions to superannuation would be worse off than a person who pays the same premium outside of superannuation.

Income protection is treated as an ancillary benefit under superannuation.

In these cases, there must also be a core benefit, such as death cover or retirement benefits within the fund, since a super fund cannot operate solely with the purpose of providing an income protection policy.

Premiums for individually owned income protection policies outside of superannuation are normally fully tax deductible.

A tax deduction is available for income protection premiums paid by the trustee of a super fund. Until March 2007, trustees of super funds could only receive a tax deduction for income protection benefits that provided a benefit period of two years or less.

Since 28 March 2007, trustees of super funds have been able to claim tax deductions for income protection cover with benefit periods of longer than two years – to a retirement age of 65.

Income benefits paid from an income protection policy, whether through super or outside of super, are taxed at the individual’s marginal tax rate. So there is no difference at the payment stage.

Income protection premiums through a super fund may be offered through group rate and may feature the same rate both for smokers and non-smokers, which may or may not be to your client’s favour.

Inside super, the trust deed must allow the payment of a temporary incapacity benefit:

• Both employees and self-employed individuals qualify for this benefit;
• Benefits are based on an own occupation definition of temporary incapacity;
• A member may be able to receive a partial disability benefit that replaces part of their income;
• Benefits must be paid at least monthly as a non-commutable income stream (ie, not a lump sum);
• A member would not be eligible for temporary incapacity benefits if they are receiving sick leave benefits, as this normally replaces 100 per cent of pre-disability income; and
• Benefits can only be paid for the period of incapacity.

Pre-disability income is not defined under super law.

Pre-disability income may be the income a client received over the past week, month, or year. Since there is no clarification, ambiguity exists.

The problem is that if the client is unemployed, on sabbatical, on maternity leave, or a homemaker and not earning an income, then they may not be entitled to any benefits from the super fund even if they have been paying premiums for the cover.

So the insurance company may still be liable to pay the benefit to the super fund, but the fund is not permitted to pay the benefit to the member.

Income protection policies outside of super are not constrained by super law, aside from the terms and conditions of the policy document.

Normally, pre-disability income is defined as the best 12 months of income during a particular period prior to disability (one year prior to claim, three years prior to claim, or two years prior to policy commencement).

Income protection insurance allows Australians to protect their standard of living. While using superannuation to pay for premiums is appealing, individuals need to be aware of the potential limitations that exist regarding benefit payments and meeting conditions of release from the fund.

Jeff Scott is the executive manager of business growth services at CommInsure.