Rethinking superannuation arrangements

Sarina Raffo takes a look at the recent trend towards insurance in superannuation and explains how changes to concessional contribution limits have affected client behaviour.

Insurance is often held within super because the premiums can be paid from accumulated super balances or employer contributions. This preserves an individual’s disposable income.

In addition, salary sacrificing or personal deductible contributions to fund insurance ensure that premiums are funded with pre-tax income.

Any eligible person can make personal deductible contributions. An eligible person is a self-employed, substantially self-employed, retired or unemployed person.

It also includes anyone for whom less than 10 per cent of total assessable income, reportable fringe benefits plus reportable employer super contributions derives from paid employment.

Concessional contribution limit reduced

Effective since 1 July 2009, the concessional contribution limit has halved compared to the previous financial year.

This has affected insurance held within super. Many people salary sacrifice into super to fund insurance premiums, and a large number of those people are under 50. People under 50 are limited to the $25,000 concessional contribution limit for 2009-10.

However, although the $25,000 annual limit is indexed, it is only indexed in $5,000 increments. Therefore it will take a number of years of indexation to increase the annual limit to $30,000 (See Table 1).

Assuming an indexation factor of 5 per cent each year, it will take until 2013-14 before the annual concessional contribution limit will be increased to $30,000 (four years time). People who are trying to save for retirement may be reluctant to divert contributions to fund insurance.

Case study

Ben, aged 45, earns a salary of $140,000 and his employer pays a $12,600 super guarantee into his super fund.

He also salary sacrifices $12,400 which takes him up to his concessional contribution limit for this year ($25,000).

As Ben is trying to save as much as possible for retirement in his early 50s, he chooses to hold insurance outside super.

This retains all salary-sacrificed contributions for retirement savings.

Alternatively, after-tax contributions can be used to fund insurance premiums. However, this does not provide the tax concessions that makes insurance through super tax-effective.

Effect on insurance arrangements within superannuation

The result is that a lot of people are rethinking their insurance arrangements within super. This may not be a bad thing to do in any case, because insurance arrangements within super should be reviewed regularly to allow for any changes to circumstances that will negatively affect the client.

However, while holding insurance through super may provide upfront tax concessions, there may be problems. Table 2 compares owning personal insurance inside and outside super.

Moving insurance to outside superannuation

When moving insurance from within the super environment to outside it (ordinary insurance), there may be superannuation law restrictions as well as provider and/or system restrictions that will require a cancellation and reissue of the insurance policy, rather than a transfer.

This may have implications for the premium levels and/or the underwriting re-assessment.

However, some insurance companies can offer the replacement policy without the client being reassessed for underwriting purposes.

As the underwriting process can be very onerous, it may be prudent to check with the insurer if reassessment is required before cancelling the old policy.

Cancelling and reissuing insurance policies is generally preferable to transferring, because it eliminates many potential capital gains tax (CGT) issues.

CGT may apply with term life insurance where the insurance proceeds are paid to someone other than the original beneficial owner and the policy was transferred for some consideration.

‘Beneficial ownership’ is determined by the entity that holds the rights and has control over the policy (usually the policy owner). However, ‘consideration’ is an ambiguous term that could be interpreted widely.

Therefore, a transfer of a term life insurance policy from the trustee of a super fund to an individual may create a CGT liability.

A transfer of a total and permanent disability (TPD) or trauma insurance policy from the trustee of a super fund to an individual will generally not create a CGT liability.

This is because CGT will only apply with these types of policies where the proceeds are paid to someone other than the insured person or a defined relative.

Where the TPD or trauma policy is transferred to the individual, it is most likely that the insured person will be the recipient of the insurance proceeds — and hence a CGT liability will be avoided.

However, if the proceeds are paid to a non-related third party, CGT may apply.

To simplify the process and negate any potential CGT implications, it is often easier and safer to cancel and reissue insurance policies rather than transfer them.

Recently super funds have seen increased numbers of members moving their insurance from superannuation to ordinary insurance.

This may be due to the restrictions imposed by the lower concessional contribution limits. Regardless, clients may wish to review their insurance arrangements within super if their circumstances have changed since the original purchase date.

However, if the decision is made to move insurance outside super, it is worthwhile checking with the insurer whether premium levels will change and/or underwriting is required. A cancellation and reissue of the insurance policy may be preferable to a transfer, since it will avoid many potential CGT issues.

Sarina Raffo is a technical services consultant at Suncorp Life.