Insurance in superannuation: the state of play

David Shirlow outlines key developments in the alignment of tax and superannuation law with respect to insurance held inside super funds.

In the last year or so, there have been a number of steps taken by the Federal Government aimed at clarifying the alignment of tax and superannuation law with respect to insurance held inside of super funds.

This article provides a brief stocktake of key developments relevant for those advising self-managed super fund (SMSF) clients, and then looks at the impact on current and future product design.

Stocktake of recent events

1. On 30 June 2011, transitional tax measures for insurance premiums ceased. These had ensured that premiums paid by SMSF trustees on some traditional forms of total and permanent disability (TPD) and other insurance could continue to attract a full deduction, notwithstanding the 2007 superannuation law reforms.
2. So from 1 July 2011, if TPD insurance policy coverage does not align with the Superannuation Industry (Supervision) Act 1993 (SIS Act) permanent incapacity condition of release, then full deductibility of premiums will not be available. 
   This and other effects of current law have now been confirmed in draft ruling TR 2011/D6, recently issued by the Australian Taxation Office (ATO). (The draft ruling also has some comments about non-deductibility of premiums for insurance covering loan repayments, but that is a story for another day.)
3. In cases where the insurance coverage is not completely aligned with the SIS rules, if the insurer has not specified the proportion of the premium which is deductible, that proportion can be established by way of the fund obtaining an actuarial certificate (not a cost-effective option for a SMSF) or pursuant to regulations made in September 2011 under the Income Tax Assessment Act 1997. 
   The regulations, in effect, prescribe the percentage of the premium which is deductible for various typical insurance arrangements.
   For example, for typical TPD "own occupation" cover (ie, insurance against an illness or injury that is likely to result in permanent inability to engage in gainful employment in the client's own occupation) the trustee can claim a deduction for 67 per cent of the premium. 
   For TPD "any occupation" cover, a 100 per cent deduction is typically available. These percentages generally apply, even if the insurance coverage also extends to activities of daily living, cognitive loss, loss of limb, or domestic duties.
4. The ATO effectively recognises (in TD 2007/3) that a premium paid for income protection cover by a SMSF trustee is fully deductible, provided the benefits are payable in accordance with the SIS regulation, temporary incapacity condition of release and associated cashing restrictions.
   The problem is, as the ATO noted in minutes of the September 2011 NTLG (National Tax Liaison Group) Superannuation Technical sub-committee meeting, there are a number of features of typical income protection policies which do not meet the SIS cashing restrictions, such as when benefits are provided for someone who continues to work part-time, where the value of the cover exceeds the person's remuneration at the time they became ill, or the level of benefits fluctuate at an annual rate of more than five per cent or CPI (consumer price index).
   The latter might occur, for example, because the person makes a partial return to work.
5. While the Government announced a number of insurance-related measures for large funds as part of its Stronger Super package, perhaps the key measure relevant for SMSFs is the proposal to require all insurance taken out by trustees to be aligned with the SIS payment standards. 

Where to from here?

These developments towards aligning superannuation fund insurance cover with the SIS benefit payment standards are already being reflected in TPD insurance product development, but there is still some way to go in relation to income protection cover.

TPD cover: Some product providers have already started aligning TPD cover with the SIS rules so that clients can obtain the 'best of both worlds' - that is, the tax efficiency of a superannuation arrangement while ensuring alignment with the payment rules.  

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One way to potentially achieve this is to take out own occupation cover, which is split into two linked policies. Part of the cover - essentially the any occupation portion of the cover (aligned with the permanent incapacity definition) - is held inside superannuation. The balance of the cover is held outside. 

In future - if the Government's Stronger Super proposal is legislated - this sort of split cover approach will be the only means by which clients with own occupation TPD can benefit from the superannuation tax arrangements.

Disability income insurance:  it can be tax efficient to arrange for income protection insurance via a SMSF if funded with concessional contributions, and it is common for policy benefits to be accessible to fund members in the event of temporary or permanent incapacity.

However, as the ATO's NTLG comments indicate, there are still some aspects of typical income protection cover which do not align with the SIS standards.

Arguably, part of the solution will be to relax the SIS rules to provide some flexibility in benefit payment levels - particularly in relation to those whose rehabilitation involves changes in work levels over time.  

Hopefully, this will be a topic for consultation between the Government and the SMSF sector early this year.

David Shirlow is the executive director of Macquarie Adviser Services.