Making insurance tax effective in superannuation
New measures introduced in the 2013 Budget will have an important flow-on effect on insurance in super, writes David Glen.
For those of us who are passionate about helping Australians to provide economic options in the event of death or disability, the 2013 Federal Budget presents challenges.
The insurance gap which we have been fighting to close in recent years, may widen in the present economic and fiscal climate. Tax pressures from Government mean less money to spend, and sadly, life insurance could be one of the household budget casualties.
Our most important asset in life is our ability to earn an income; without it the consequences can be devastating.
Rice Warner actuaries show total under-insurance nationally at a staggering $10.6 trillion, with the disability gap increasing 10 per cent in 2012 to $7.9 trillion, the income protection gap up 30 per cent to $589 billion and the end-of-life insurance difference pleasingly down 30 per cent to $2.166 trillion.
On the positive side, middle Australia can breathe a sigh of relief as the Federal Government’s revenue-raising measures could have seen a more intense attack on Australia’s superannuation savings, and also a substantial reduction in the tax savings for those who seek life insurance cover via superannuation.
While the measures announced on 14 May make no specific mention of life insurance, it is important not to ignore the flow-on effect of these measures on the affordability of life insurance.
Many clients in recent years have structured their life insurance holdings through superannuation on the basis that this offers tax and cash flow advantages.
Insurance through superannuation can be funded by tax-deductible contributions, and accumulated superannuation balances can also be used to fund short-term life insurance needs. However, customers should regularly review their strategies in the light of these announcements.
The $35,000 concessional cap threshold
For the 2014 income year, contributors over the age of 60 will have a concessional superannuation contributions cap of $35,000 per annum, instead of the existing cap of $25,000 per annum.
This increased cap will be extended to those aged over 50 in the following year.
The Federal Government has wisely abandoned the $500,000 balance test for the increased concessional contribution cap for those aged over 50, on the basis that monitoring member balance levels would have created an administrative nightmare for everyone involved.
The $35,000 cap falls well short of the concessional cap limits for the over-50s in previous years, but the increase is a welcome measure in the present difficult fiscal climate, and will encourage those close to retirement to boost their retirement savings by increasing their superannuation contributions.
These measures will also assist and encourage customers to take their life insurance via superannuation, as this route continues to be the most tax-efficient way of funding the cost of life cover.
There may be members of these age groups who would prefer to forego the tax benefits of life insurance in super by taking insurance outside superannuation, and increasing their retirement savings. Advisers will again play a crucial role in assisting customers making this important choice.
Excess contributions tax strategies
The excess concessional contributions tax measures will be modified to provide an opportunity for members to request the excess to be refunded, and the refunded amount will be taxed in the hands of members at their marginal tax rates.
There will also be an interest charge to recognise the fact that the excessive contribution has resulted in a delay in the payment of tax.
This measure may assist those individuals who have made excessive concessional contributions as a result of placing their life insurance in super.
However, advisers should urge members to consider whether or not this option is effective.
It may be a more effective strategy at the maximum marginal tax rate to fund insurance in superannuation via contributions in excess of the concessional contributions cap.
This option often has a lower after-tax cost than the alternative of taking insurance outside superannuation.
The new interest charge will probably be applicable in this case, but this should not invalidate the strategy as the tax liability is also deferred under this strategy. The interest is simply compensation for the deferral of the tax liability.
It is important to note that the refund measures do not apply to the tax payable in the event of a breach of the non-concessional contributions cap. Tax will continue to be imposed at the rate of 47 per cent on after-tax contributions making this an expensive outcome if non-concessional caps are breached.
High net worth customers funding their insurance in superannuation are particularly vulnerable to this punitive tax.
For example, a medical practitioner may be making concessional and non-concessional contributions equal to the respective caps for retirement savings purposes.
This medical practitioner may also inadvertently take his life insurance via superannuation. This customer will face the prospect of his excess after tax contributions funding his life insurance needs being taxed at the punitive rate of 47 per cent.
Timely advice would warn the medical practitioner of this danger so that his life insurance needs can be structured outside superannuation.
$100,000 per annum pension limit
This measure was announced in early April, and the Federal Government has confirmed its commitment to this measure in the Budget papers.
Where the pension income of a superannuation fund exceeds $100,000 per member, the excess will be taxed at the rate of 15 per cent.
Under the present regime, income earned by superannuation funds on assets supporting pension liabilities are free of tax. This measure will be effective from 1 July 2014.
This measure needs also to be taken into account when formulating strategies for the investment of death benefits paid to the dependants of superannuation fund members.
Often, it is more tax efficient to retain these funds in the concessionally taxed superannuation environment.
This can be achieved by distributing the death benefit in pension form to the surviving spouse and/or children who qualify as pension dependants.
The pension may be tax free in the hands of the recipient, or qualify for the 15 per cent or low income rebate.
The new measures could create an additional impost where the pension exceeds $100,000 per death benefit dependant.
However, in spite of this additional impost, it is likely that this option remains more tax effective than the option of taking the death benefit in lump sum form, and investing it outside the superannuation environment where the income is taxed at the beneficiaries’ marginal tax rates.
Deferred lifetime annuities
Income on assets invested to provide deferred lifetime annuities will be exempt from tax with effect from 1 July 2014.
A deferred lifetime annuity is an annuity that is purchased for an upfront premium, but the commencement of the annuity payments is deferred to a point in the future.
For example, a retiree aged 60 will be able to use the tax-free lump sum to purchase an annuity where the annuity payments commence at say, aged 80.
The existing taxation law only confers tax-exempt status on income earned on assets which support the liability to pay an immediate pension or annuity.
These measures are a positive first step towards addressing longevity risk where superannuation fund members outlive their retirement savings.
However, it remains to be seen whether or not consumers will be far-sighted enough to embrace these products.
The challenge for life insurers and advisers offering such products will be to engage consumers on longevity issues, and to make these products attractive and understandable them.
Opportunity for advisers
Advisers will continue to play a crucial role in assisting clients to identify the most effective life insurance options based on their individual circumstances.
The new measures therefore will also require customers and advisers to review previous strategies.
Unfortunately, superannuation rules change on a regular basis, and such change will continue to be a feature of the landscape, irrespective of the political party in Government. Regulatory change risk should always be factored into in any life insurance or superannuation-related strategy.
David Glen is tax counsel at TAL Life.
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