Income protection insurance – traps and tricks

Income protection (IP) insurance is a must for clients seeking protection for their biggest asset, namely their ability to earn an income. However, there are a few traps and tricks for wealth professionals to be aware of.

Outside super

Premiums are only tax deductible where it can be proven that they relate to the earning of assessable income, with the proceeds of any payout considered assessable income also.

Where IP premiums are paid by an employer, the employer claims a tax deduction, not the client. However if a benefit is paid to the client, they will need to include the insurance proceeds as assessable income and pay tax at their marginal rate.

In addition to the tax deduction, keeping IP outside super offers a number of features and benefits, usually contained within premier policies such as nursing or rehabilitation benefits that are unavailable when taken within a superannuation fund.

Inside super

For young families, cash flow and affordability are two reasons why holding IP insurance inside super makes sense. Increasing salary sacrifice contributions to match the premium payments, thereby also indirectly reducing a client’s taxable income, can offset the drain on super fund balances.

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However, premiums funded by super contributions count towards the concessional contribution cap, while accessing the insurance requires satisfying both the terms and conditions of the insurer’s policy contract and also the requirements of superannuations’ temporary incapacity condition of release.

While benefit payments can continue should the client make a partial return to work while incapacitated, their remuneration plus the benefits cannot exceed their income before they became ill. For this reason, IOOF suggests structuring agreed value policies outside super.

It is also important to ensure that the super fund’s definition of pre-disability earnings is in alignment with the insurer’s, that the trustee’s definition is in compliance with super law and that the super fund’s governing rules are not more severe than legally required.

Do the math

Aim for a win-win negotiation with clients over the costs and benefits from their IP cover. For cost-conscious clients, extending the waiting period can help reduce premiums while still maintaining a high level of benefits, thereby ensuring both client and adviser benefit (refer IOOF’s Technical Insurance Guide on:

http://www.ioof.com.au/insurance#download.

Clients with access to salary packaging can also benefit from IP, since they can pay premiums in pre-tax dollars rather than after-tax dollars, instead of having to wait until the end of the financial year to claim a tax deduction.

For clients who are offered only limited or no cover, a strategy to overcome this is capitalising the uninsured section of income in a trauma or TPD policy. This is in the best interests of the client, since they need to protect 100 per cent of their income.

For more tips on maximising the benefits of IP cover for you and your clients, refer to IOOF’s Technical Insurance Guide on: http://www.ioof.com.au/insurance#download, written for and by advisers.