Keeping a handle on insurance in SMSFs

Insurance cover through a self-managed superannuation fund (SMSF) can be very beneficial for a number of reasons.

Firstly, where a member is making salary sacrifice contributions, they can effectively pay the premiums with pre-tax money or, in the case where a member is personally entitled to a tax deduction for their contributions, they can effectively claim a tax deduction for the premiums.

In addition to this, the insurance premiums are generally tax deductible to the superannuation fund.

The abolition of reasonable benefit limits resulted in the ability for members to fund larger amounts of insurance without being subject to penalty tax opening up the opportunity to move insurance into superannuation.

Trustees of SMSFs, as with any transaction or investment, need to be conscious of the various Superannuation Industry Supervision Act (SIS) requirements when holding insurance through their SMSF.

Particular caution should be taken when transferring insurance into a SMSF.

Acquiring a life insurance policy from a member

Section 66 of the SIS Act provides that a trustee of a SMSF is prohibited from acquiring an asset from a related party of the fund, subject to limited exceptions.

While a term life insurance policy, for example, does not necessarily have a specific cash value, it is considered an asset for the purposes of the SIS Act and trustees of SMSFs will need to ensure the acquisition of asset rules are not breached.

The definition of a related party is quite broad and includes any of the following:

n a member of the fund;

n a standard employer sponsor of the fund; and

n a Part 8 associate of a member or employer sponsor of the fund (Part 8 associates include related individuals, companies, trusts and partnerships).

There are limited exceptions to the related party rules including:

n listed securities;

n business real property;

n an in-house asset where the acquisition would not result in the level of in-house assets of the fund exceeding 5 per cent of the total assets of the fund; and

n a life insurance policy issued by a life insurance company (other than a policy acquired from a member or relative of a member of the fund).

Although life insurance policies are provided as an exemption to the acquisition of asset rules, the exemption does not cover life policies that are acquired from a member or a relative of a member of the fund.

Therefore, if a trustee of an SMSF was to accept a transfer of a term life policy from a member or relative, the fund would in fact breach the acquisition of asset rules, jeopardising the complying status of the fund.

In addition, the trustee could be subject to civil and criminal penalties.

There is a potentially simple solution to this problem.

Where an individual has an existing life insurance policy outside of superannuation and wishes to transfer it to the SMSF, they can ask the life insurance provider to cancel the existing policy and reissue a new policy in the name of the trustees of the superannuation fund. The cancellation and reissue of the policy means the cover is effectively transferred to the SMSF without a breach in the acquisition of asset provisions.

However, careful consideration should be given to ensure the individual does not lose any benefits from the original policy when having the policy reissued in the name of the fund.

In most cases, there is no additional risk for the provider and they may allow the cancellation and reissue without additional underwriting.

Some providers may nevertheless see this as an opportunity to refresh the terms and conditions available on the policy to the policyholder’s detriment.

Trauma insurance

Holding trauma insurance within a SMSF brings with it a number of complications.

Firstly, trauma insurance provides a lump sum payment for those who suffer a specified major health trauma such as cancer or heart attack.

While a claim may be made on the trauma policy, individuals claiming under the policy won’t always have access to their superannuation benefits, as they may not be able to meet the definition of being permanently incapacitated. This means the proceeds of the policy may not be available for their intended purpose.

Another limitation of holding trauma insurance through superannuation is the potential adverse tax treatment.

The SMSF is generally not eligible to claim a tax deduction on premiums. Upon a claim, the proceeds of the policy may be subject to capital gains tax within the fund.

Furthermore, any payment to members may also be treated as assessable income and therefore taxable to the member.

Finally, there are arguments to indicate that trauma insurance may not satisfy the sole purpose test.

While the sole purpose test provides that one of the ancillary purposes of the fund can be to provide benefits for each member of the fund in relation to ill health, the ability of the member to access the benefits may compromise this purpose.

Holding trauma insurance within superannuation raises many questions and it is generally better to hold it outside superannuation.

Term life superannuation policies

Term life superannuation policies are life insurance policies held within a superannuation structure.

Holders of term life superannuation policies are considered members of the fund, albeit their benefits are limited to the insurance benefit provided within the policy.

Like any other type of superannuation fund, to be complying and receive the tax concessions available, it must meet all legislative requirements under SIS.

A common mistake by SMSF trustees is to take out a term life superannuation policy. Unfortunately, a superannuation fund cannot hold an interest in another superannuation fund. This is because only individuals can be members of a superannuation fund. As a result, payments made from an SMSF to a term life superannuation policy will effectively be rollovers.

Trustees should therefore ensure that only ordinary term life insurance policies are held on the lives of the members of the fund.

Sean Howard is the technical manager at Westpac Financial Planning.