Insurance and super inside out
Holding insurance inside superannuation can be a tax-effective avenue due to the range of concessions available when making super contributions, Fabian Bussoletti writes.
Holding insurance cover inside super has been a popular solution for many clients and a default position for many of those in employer or corporate super plans.
This article looks at some of the benefits and key considerations of holding the two most common types of insurance cover within super — life, and total and permanent disability (TPD) cover.
Insurance in super — benefits
One of the advantages of holding insurance in super is the ability to use various funding methods to meet the cost of premiums. Depending on the client's situation, the premiums can be funded using pre-tax (salary sacrifice or personal deductible) contributions, after-tax contributions, or accumulated super savings.
Further, because the trustee can generally claim a tax deduction for insurance premiums, any taxable contributions made to the fund that are then used to pay premiums, effectively do not attract contributions tax.
Trustees can generally claim 100 per cent of the insurance premiums as a tax deduction for term life, certain TPD policies, and income protection policies.
TPD insurance premiums are only deductible to the extent that the policy relates to the fund's liability to provide permanent incapacity benefits. Broadly, this means TPD insurance premiums will only be deductible to a super fund to the extent that the policies are attributable to the fund's liability to provide ‘any occupation' permanent incapacity benefits.
Alternatively, premiums can be paid using the individual's accumulated super benefits — meaning that the member will not need to pay insurance premiums from their own pocket. But funding premiums like this may erode retirement savings over the long-term.
Note: Contributions made to fund insurance premiums will continue to count towards the member's relevant contribution caps.
Other potential advantages include:
- Cheaper premiums: Potentially in larger funds because of economies of scale.
- Automatic underwriting: Some funds may offer group plans with automatic underwriting. This will be attractive for individuals who have pre-existing medical conditions and who would otherwise not be able to obtain the required level of cover.
PITFALLS
Life cover within super
Beneficiaries
Unlike insurance policies held outside of super, super death benefits (including life insurance proceeds) can typically only be paid directly from the super fund to someone who is either their super dependant or legal personal representative (i.e. their estate).
Tax treatment
The tax treatment of a lump-sum super death benefit depends on whether the recipient is a dependant or a non-dependant for tax purposes, and the form of the death benefit (i.e. lump sum or income stream).
A dependant will receive a super lump sum death benefit tax-free, irrespective of the underlying tax components.
Non-dependants will pay tax on the lump sum death benefits, as shown in Table 1.
Note: Where a super trustee has been claiming a tax deduction for the cost of the insurance premiums, life insurance held within super creates an untaxed element when the death benefit is paid as a lump sum.
It should also be noted that death benefits may also be paid in the form of a death benefit pension to a limited range of beneficiaries (e.g. to a surviving spouse).
Where the death benefit is paid in the form of an income stream, the tax treatment of the income stream payments depends on the age of the deceased and/or the age of the beneficiary as shown in Table 2.
TPD
The insurance claim and the condition of release
While it has not been possible to establish a new "own occupation" TPD policy inside super since 1 July 2014, super funds may still hold grandfathered TPD "own occupation" policies for members.
So in some situations, a member might meet the insurer's definition of disability (potentially under an ‘own occupation' definition), resulting in the proceeds being paid to the fund trustee. However, unless the narrower Superannuation Industry (Supervision) Act 1993 definition of permanent incapacity is also satisfied, the super benefits will remain preserved.
Unlike insurance policies held outside of super, super death benefits (including life insurance proceeds) can typically only be paid directly from the super fund to someone who is either their super dependant or legal personal representative (i.e. their estate).
The permanent incapacity condition of release requires that the trustee is reasonably satisfied that the member is unlikely, because of ill-health, ever again to engage in gainful employment for which the member is reasonably qualified by education, training or experience.
This will not be the case if the member has met a different condition of release (e.g. the member has reached preservation age and retired, or is age 65 or older).
Taxation of TPD benefits
A common misconception is that TPD insurance held within super can be paid tax-free to the member following the release of the benefit on the grounds of permanent incapacity. However, the tax payable (if any) will depend on the age of the member at the time the benefits are received, whether they are paid from a taxed or untaxed fund, and whether the benefit is taken as a lump sum or an income stream.
Upon withdrawal, the taxable component (paid from a taxed super fund) is subject to tax as shown in Table 3.
Note: Under the proportioning rules, tax-free component cannot be taken out separately from taxable component. Each withdrawal will contain both tax-free and taxable components in proportion to the overall account balance.
While a lump sum benefit is unlikely to be completely tax-free, an increased tax-free amount (in addition to any tax-free component the member already has in the super fund) may be available if the payment qualifies as a disability super benefit.
An increase in the tax-free componont due to disability can only be calculated upon the crystallisation of a super benefit. The crystallisation of the super benefit occurs when the payment is taken as a cash lump sum or the amount is rolled over to a different fund.
Instead of taking benefits as a lump sum, TPD benefits can usually also be taken as an income stream, depending on the clients' circumstances.
Where such an income stream is classified as a disability super pension, for people under age 60, the taxable portion of the income payments will be subject to a 15 per cent tax offset. Of course, for people aged 60 and over, the income stream from a taxed fund will be received completely tax-free.
Further, the investment earnings derived within these pension accounts will be exempt from tax, regardless of the client's age.
So, particularly for clients under age 60, the ability to take TPD benefits in the form of an income stream if it is suitable may provide them with a more tax effective solution.
Note: Commencing an income stream within the same fund will not automatically give rise to an increased tax-free component (discussed earlier).
Fabian Bussoletti is technical services manager at AMP TapIn.
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