Is insurance inside super a good strategy?
While we all know that structuring your insurance inside a superannuation fund can be tax effective as well as cost effective; not everyone is convinced that the benefits can outweigh the restrictions.
The common concern is the perception that the benefits will get “stuck” in the super fund and not paid to the clients directly or that when the benefits finally do get paid, the client will be liable for a massive tax bill.
While there may be some truth to the above perception, there are ways to manage these to ensure that you get the benefit of a cost and tax effective insurance premium without sacrificing the benefits at claim time.
1. Meeting a condition of release
When an insurance policy is held inside super, the owner of the policy is the trustee of the super fund. Any proceeds paid in the event of a claim are paid to the super fund and then a superannuation condition of release needs to be met in order for your clients to get their money out of super.
Most products allowable inside a super fund are designed to meet a condition of release to help facilitate a smooth transfer from super fund to the claimant. For example, with term life and income protection insurance, there is usually no issue with releasing proceeds from super as ‘death’ and ‘temporary incapacity’ are conditions of release.
TPD meets a condition of release if you also meet the definition of ‘permanent incapacity’ (or another condition of release) under superannuation legislation. Any occupation TPD generally will meet this condition however policies such as own occupation TPD or trauma may not meet this requirement. Generally, individuals will apply for release of their TPD or trauma insurance proceeds through the ‘permanent incapacity’ condition of release. If this is not met, then those funds stay in the super fund until the client can meet the ‘permanent incapacity’ condition or at preservation age.
Managing the risk
The best way to ensure a smooth transfer of the death benefit from the trustee is to ensure that there is a valid binding nomination of beneficiary. This should be constantly reviewed as your situation changes. In most instances, the delay happens when the trustee is required to determine beneficiaries.
As for own occupation TPD and Trauma; if these funds are required for immediate use then it may be best to have them outside superannuation unless you are close or already at your preservation age.
2. Taxation of benefits
The tax treatment of insurance proceeds has some variables but most importantly, not all proceeds are taxable.
- Life cover – If the benefit is paid to a tax dependant, the proceeds are tax-free. So it’s only when the recipient is a tax non-dependant (e.g. an adult child) that benefits are taxable.
| Component |
Tax rate (including Medicare levy) |
| Taxable (untaxed) |
31.5% |
| Taxable (taxed) |
16.5% |
| Tax-free |
0% |
- TPD – The tax treatment is based on the claimant’s age. Generally, the older the individual, the less the applicable tax rate is. At age 60 and over, the benefits are tax free.
| Age |
Tax rate (including Medicare levy) |
| Under preservation age |
21.5% |
| Preservation age but < age 60 |
16.5% (The first $165,000 is tax free in 2011/12) |
| Age 60 + |
0% |
Note: If the individual qualifies for a disability super benefit, this will increase the tax-free component.
Managing the tax treatment
Grossing up the sum insured enables your client to pay the tax without depleting the required benefit amount. You can do this by first calculating the tax liability and then grossing up the sum insured to take into consideration the tax payable. In most instances, grossing up the sum insured and paying with pre-tax dollars is still more cost effective than paying the lower sum insured outside super with after tax dollars.
For example: If you are 40 years old with a marginal tax rate at 38.5% and claimed at age 54, below would be your tax liability:
| |
Outside Super |
Inside Super at age 54 |
| TPD sum insured |
$1,000,000 |
$1,000,000 |
| Tax payable |
$0 |
$137, 256 |
| Gross sum insured |
$1,000,000 |
$1,140,000 |
| Annual premium |
$1, 573 |
$1,668 |
| Real cost |
$2,557 |
$1,668 |
This can also be done for life cover to be paid to non tax-dependents.
Remember, the older you get, the less tax will be required, so it helps to have a continued conversation between yourself and your financial adviser.
Is insurance in super a good strategy?
Holding your insurance inside super holds many benefits and the risks and restrictions can be managed with careful planning. The most important thing is to ensure you don’t dismiss this strategy based on misconceptions.
Like anything, your adviser will consider your individual circumstances and will help you determine whether your insurance should be held inside or outside super. In many cases, you may find the optimal outcome involves a combination of both.
Contact us to discuss insurance in super strategies in more detail.
