It’s possible to hold various forms of life insurance in a self-managed super fund (SMSF), but should you?
Careful consideration should be given whether to hold it within an SMSF or in the member’s personal name outside super because this decision will determine who the policyholder is and the benefits that follow.
While there are benefits to holding life insurance policies in your SMSF, superannuation legislation and taxation considerations may curtail its appropriateness in specific circumstances.
Benefits of insurance in your SMSF
The most obvious benefits of using SMSFs to pay insurance premiums are:
Tax effectiveness: Salary sacrificing into an SMSF effectively enables premiums to be paid from a person’s before-tax income. The higher the person’s marginal tax rate, the greater the saving. Similarly, if a member is able to claim a tax deduction for their personal contributions – for example, someone who is self-employed – they are ultimately claiming a tax deduction for the premiums. These tax outcomes are generally not achievable where insurance is held outside super.
Personal cash flow benefits: If a member chooses not to make super contributions to fund the insurance premiums, then premiums can be paid using amounts already accumulated in the SMSF, including compulsory employer contributions and fund earnings. This way, the member doesn’t pay for the premiums personally; their personal cash flow remains intact.
SMSF Deductions: With the exclusion of trauma insurance, premiums are generally tax-deductible to the fund. Additionally, where an SMSF holds a policy for a member who passes away or becomes disabled, the SMSF may claim a deduction in that year for the ‘future service’ element of the death or ‘total permanent disability’ (TPD) benefit paid. This deduction could be quite substantial depending on the member’s circumstances.
Restricted access to payouts
So, an SMSF may seem like an obvious choice for holding insurance, but remember, if the SMSF is the policy owner and is paying premiums, then any insurance proceeds must be paid into the SMSF. As such, a condition of release must be met before the money can be released to the member.
The dilemma this creates is whether the SMSF can legitimately release the proceeds as, and when, they are required. This is relatively straightforward for life cover because the insurance policy is paid in the event of death or terminal illness, both of which are specified conditions of release. However, some cases can be less transparent.
Things to think about
Some key considerations when deciding whether to hold insurance inside an SMSF include:
Trauma insurance: Trauma cover inside SMSFs, whilst permitted, has largely been rendered ineffective. Most trauma events would not alone be sufficient to meet a condition of release, resulting in the insurance payout being trapped inside the SMSF at the time of need.
TPD insurance: The way TPD is defined in the insurance policy will be critical in determining whether a claim is paid and if the proceeds can be released to the member. TPD cover can be provided under ‘own occupation’ or ‘any occupation’. The terms of TPD ‘own occupation’ are likely to be narrower than the permanent incapacity definition under the super laws.
So while this may be considered more appropriate for a member, it may result in the insurance proceeds being retained in the SMSF until an effective condition of release is met.
Conversely, the more general ‘any occupation’ definition could be harder to successfully claim against, but is better aligned with the super laws’ permanent incapacity definition.
Split policies: There may be scope to split certain insurance policies by retaining the portion matching the super law definitions within the SMSF, and the remaining portion outside. This structure can help to maximise tax benefits without entirely jeopardising accessibility of insurance proceeds.
Further, premiums for TPD ‘own occupation’ definition will only be partially deductible. The super laws prescribe a percentage of TPD insurance costs that can be claimed as a deduction.
Payment restrictions: Similar payment restrictions may exist where income protection policies are held in an SMSF. This can occur where cover is provided on an agreed value basis but the claim value (that is 75% of the member’s income at the time the policy was taken out) exceeds the member’s income at the time the claim is made. This excess amount would be trapped in the SMSF until a further condition of release is met.
Taxation: Life insurance proceeds are taxed if paid to non-dependents for tax purposes, which include independent adult children over the age of 18. The tax amount could be up to 31.5% which would significantly deplete the death benefit.
Fund balance: Insurance premiums paid from SMSFs will reduce the balance of your fund. This is especially relevant for members who are not working – such as members on parental leave or long service leave – if contributions are not made to the SMSF to replenish the outgoing value of the premiums.
And remember, premiums may only be paid by an SMSF where the fund is the owner of the policy. If the SMSF pays the premiums for a policy owned by the member, this could break the rules concerning the early release of superannuation.
Life insurance premiums paid by the SMSF have definite benefits, but careful consideration should be given to a number of potential pitfalls.
Important information: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. For this reason, any individual should, before acting, consider the appropriateness of the information, having regard to the individual’s objectives, financial situation and needs and, if necessary, seek appropriate professional advice.
