Should I hold life insurance inside my self-managed super fund?
When it comes to life insurance, Australians are notoriously under insured. That is, we don’t hold sufficient life insurance to provide for the financial well-being of ourselves and our family in the event of death, diagnosis of a terminal illness, permanent, or temporary disablement.
However, for those that do have life insurance in place, it is often held as part of our superannuation. That is, we may have some life, total and permanent incapacity and/or income protection insurance as part of our superannuation arrangements. Often insurance held through superannuation is not well understood.
In recent times, some of the rules around holding insurance through a self-managed superannuation fund have changed. This article looks at some of those changes and what needs to be done, if anything.
Self-managed superannuation funds
With over 1,000,000 Australians now belonging to a self-managed superannuation fund (SMSF), it is worth revisiting some of the requirements around insurance and SMSFs. If you are a member of an SMSF, you are also a trustee or director of a corporate trustee. Being a trustee carries additional responsibilities as you need to ensure your fund operates in a compliant manner. Failure of a SMSF to comply with relevant superannuation laws may result in the fund losing its concessional tax treatment, and/or penalties being imposed personally on the trustees of the fund.
In order to comply with relevant superannuation laws, each SMSF must create, regularly review, and invest in accordance with a properly formulated investment strategy. An investment strategy is a document that identifies the key objectives of the SMSF and how the trustees will be investing the SMSF’s money to achieve its overall investment objectives.
Back in August 2012, the laws were changed and trustees are now required, as part of their investment strategy, to consider whether their SMSF should hold insurance on the life or lives of one or more members of their fund. This relatively new requirements places potentially far-reaching obligations on each one of us, as trustees.
Importantly, the legislation does not mandate that trustees must take out insurance on the lives of members but rather, that they consider whether insurance should be effected, after taking into account the whole of a member’s personal circumstances.
As the regulation that impose this requirement is one of the regulations the SMSFs auditor is required to sign off on each year, auditors look for some evidence that the trustees have considered the insurance needs of their Fund’s members.
Analysing the insurance needs of a SMSF member is not a simple process. Trustees seeking to ensure they have fully complied with the relevant legislative obligations may be well served by asking a suitable qualified and licensed insurance adviser to conduct a review of the insurance needs, if any, of the members of their SMSF. Such a review would generally satisfy the needs of the fund’s auditor.
Permissible types of insurance
With effect from 1 July 2104, further changes to superannuation laws restrict the types of insurance that trustees of a superannuation fund can effect on the life of a member. This change not only applies to SMSFs, but to all types of superannuation funds including employer sponsored, industry, and retail funds.
In essence, the only types of insurance that can now be arranged through superannuation are those policies that provide for the payment of a benefit that is aligned to a superannuation “condition of release”. Without getting into the technicalities of the superannuation preservations rules and conditions of release, superannuation funds are now only able to issue insurance on the lives of members that will pay a benefit in the event of any of the following events occurring:
- Death of a member;
- Diagnosis of a member suffering a terminal medical condition;
- Becoming permanently disabled (i.e. unlikely, because of ill-health, ever to be gainfully employed in any occupation for which the member is qualified by education, training or experience);
- Temporary disablement (i.e. temporarily unable to work due to ill-health. In this case, a superannuation benefit can only be released as an income replacement benefit for the duration of the incapacity. Limits apply.)
The restrictions on the types of insurance that can be held through superannuation only apply to insurance policies effected from 1 July 2014. Where a policy of insurance was in place before 1 July, such policy may continue to be held through superannuation into the future, even if the insured events are not aligned to a superannuation condition of release. This is known as “grandfathering”.
Structuring of insurance
Apart from satisfying the requirements to consider insurance on the life of a member of a SMSF, insurance may be held through superannuation for a number of reasons. These include:
- Managing cash flow – by having a superannuation fund pay the premiums rather than the member having to pay them from their own pocket;
- Allowing insurance proceeds to be retained in the concessionally taxed superannuation environment by paying a benefit as a pension or income stream to a surviving spouse, or to young children;
- To allow an increased benefit to be paid to a member in the event of their death, permanent, or temporary disablement;
- To use the insurance proceeds to repay debts held by a SMSF;
- To enable the trustees of a SMSF to manage liquidity. This may arise where a fund has a large illiquid asset (such as property) and the trustees don’t want to be forced to sell an asset in order to be able to pay a benefit to a member or their beneficiaries.
Given the competing reasons that may exist for holding insurance through superannuation, the correct structuring of that insurance can be complex. In particular, where a SMSF has debt or a significant part of the fund’s wealth is committed to a single asset, and the insurance proceeds are to be intended to manage debt or the cash flow needs of the fund, specialist advice should be sought to ensure the correct structuring, so that the insurance proceeds don’t inadvertently add to the insured member’s superannuation account.
More generally, there will be cases where it may not be wise to hold insurance within superannuation. Particularly, where insurance proceeds will be passed to a non-dependent of a deceased member (e.g. an adult child), the insurance proceeds may be taxed at a rate of up to 30%.
Holding insurance through superannuation is common place but is not a “one size fits all” strategy. Determining how much and what types of insurance to hold will differ from person to person.
Recent changes to superannuation laws not only impose a requirement on trustees of SMSFs to consider the insurance on the lives of their members, but restrictions now also apply to the types of insurance that can now be held through super.
Seeking the advice of an appropriately qualified and licensed insurance specialist can be worth its weight in gold.