Funding TPD cover inside superannuation

Other drivers include funding the ongoing cover with pre-tax income or accumulated superannuation savings as well as having the insurance proceeds bypass the contributions caps.

Group versus retail cover

Just as group policies can be a godsend for some individuals, they may be less welcome by others.

Employer super schemes, along with certain personal super plans, typically offer their members insurance coverage through group insurance arrangements. Also available under some personal super plans is retail insurance coverage, which is maintained as an insurance-only member account.

Stepped and level premiums

Group policies are usually offered on a stepped premium basis, with premiums increasing over time. Retail policies make available both stepped and level premiums or a combination thereof, potentially delivering a saving over the long term for members paying level premiums.

Continuation options

Individuals establishing superannuation-owned cover should ensure favourable continuation options are offered under group arrangements in the event they leave their fund at some stage. Many group policies offer some form of continuation on death cover, although TPD and salary continuance may prove problematic at times. This isn’t an issue for retail policies, as all covers are generally fully portable.

Standalone covers and sums insured

Members wanting group TPD cover must attach this to the death cover they hold under the same policy, with the TPD sum insured not to exceed that for death cover. This restriction may force members to explore options in the retail policy market if a higher TPD cover sum insured is required — for example, to account for lump sum super taxes on TPD payouts.

Policy features

Individuals should refer to policy wordings and definitions to determine the extent of their entitlements. Retail policies tend to offer more ancillary benefits as standard and optional policy features than group policies.

TPD definitions

TPD coverage under group policies will utilise the ‘any occupation’ TPD definition as compared to the choice on offer through retail coverage. Retail policies may be underwritten on the basis of ‘any occupation’, ‘own-occupation’ and ‘non-working’ definitions. Policies triggered under the ‘own-occupation’ or ‘non-working’ definitions may not be immediately accessible to the incapacitated fund member.

Accessibility of insurance proceeds

Importantly, proceeds of superannuation-owned insurance policies are payable to the super fund. The fund is only able to release TPD cover proceeds to the member in a manner permissible by the fund’s trust deed and the law.

‘Permanent incapacity’ is the most notable release condition for accessing TPD and trauma proceeds. This requires the fund’s trustee to be reasonably satisfied the member is unlikely, because of physical or mental ill health, to engage in gainful employment for which they are reasonably qualified by education, training or experience — this is an ‘any-occupation’ TPD definition. The definition can be problematic if a member fails the ‘permanent incapacity’ definition yet requires access to proceeds paid under their superannuation-owned ‘non-working’ TPD or ‘own-occupation’ TPD policies.

Nonetheless, members who have attained their preservation age (currently age 55) can bypass ‘permanent incapacity’ and access their benefits under other qualifying release provisions such as ‘retirement’, ‘severe financial hardship’ and ‘transition to retirement’.

Another possible release avenue is the recently introduced ‘terminal illness’ provision. A fund member is taken to be terminally ill if two medical practitioners (at least one being a specialist) certify they are suffering from an illness that in the normal course will result in death within a period of 12 months. The ‘terminal illness’ provision allows unrestricted access to TPD cover proceeds.

Taxation of insurance proceeds

There are a number of key dates when calculating the tax-free and taxable components of a ‘disability superannuation benefit’ (defined below). These include the member’s service period start date, last retirement day and date of permanent incapacity.

The service period start date is the earliest of the following dates:

• establishing fund membership;
• service period start date of a rollover made to the fund; or
• date of employment with an employer who has made employer contributions to the fund.

The ‘last retirement day’ is taken to be the member’s 65th birthday, unless an employment agreement is in place which stipulates an alternate cessation date (for example, a fixed-term contract).

The member’s ‘total service period’ is the timeframe from their service period start date to their last retirement day.

The member’s completed service is the period from their service period start date to their date of permanent incapacity.

The following tax summary assumes a condition of release has been met.

Lump sum taxes

Tax-free lump sums apply to members who satisfy the ‘terminal illness’ definition (discussed above) within 90 days of receiving the super lump sum, or to members who make withdrawals on or after their 60th birthday. Otherwise, the lump sum’s taxable component is taxed according to the table below.

Where the member meets the ‘any-occupation’ TPD definition (referred to as ‘disability superannuation benefit’ under tax law), the lump sum will qualify for a tax-free component, which is calculated using those important dates we looked at earlier.

1. Determine the lump sum’s tax-free component, which is the lesser of the:

• lump sum payment; or
• tax-free component of the member’s super account balance, which will form part of the lump sum plus the tax-free component created on payment of a ‘disability superannuation benefit’ (equal to the total lump sum payment multiplied by the member’s incomplete service percentage).

2. Determine the lump sum’s taxable component, which is the remainder, if any, of the lump sum.

Taxes on pension payments

Generally speaking, the taxable component of ongoing pension payments is taxed at marginal rates (less a 15 per cent tax offset) until the member’s 60th birthday.

Where the ‘disability superannuation benefit’ definition has been met, a super rollover made prior to establishing a pension will trigger the tax-free component calculation (see the lump sum taxes subsection). This helps increase the tax efficiency of the pension.

Conclusion

The strong competitive nature of the personal insurance market provides consumers with many great products and features to choose from. Those shopping around for cover are faced with many decisions, including the suitability of various ownership structures, funding options, sums insured, group versus retail cover, policy features and much more.

Rudy Haddad is the national manager, Technical Services, ING Australia.

The information in Toolbox is intended for financial planner use only. Any advice contained in these articles does not constitute personal financial product advice. Therefore, before making any decision to act or rely on any advice in this document, planners should consider the appropriateness of the advice with regard to their client's particular objectives, financial situation and needs.