Advantages of insurance cover

john wasiliev

Since the removal of reasonable benefit limits, designed to restrict the amount of tax concessional super that could be accumulated over a lifetime, taking out life and disability insurance through a self managed superannuation fund has become more attractive.

“These days we normally recommend people with DIY super take at least their life insurance cover through their super,” says Godfrey Pembroke financial planner Matthew Scholten.

Taking life cover via super has advantages when compared to buying cover personally.

The key difference, says Scholten, is that the DIY fund owns the policy and pays the premiums, and so it eligible for a tax deduction for the expense where the policy provides cover for the risk of death.

If a policy is funded personally, the premium is paid with after-tax dollars.

This makes the super strategy more cost and tax effective.

Despite the benefits, Scholten notes that many DIY funds fail to exploit them, mostly because they don’t think about it.

Life insurance is more often than not “sold” to consumers, and unless the DIY fund member comes across an adviser who recommends protection, they are unlikely to consider it.

In the case of standard insurance, such as life cover, the fund owns the policy, so if it is ever called upon, the proceeds are paid to the fund and the fund pays a death benefit to the beneficiary or beneficiaries.

The way in which the benefit is taxed will be influenced by whether the beneficiary is a financial dependant. If a spouse receives the death benefit, or a “minor child” – a child who is not yet 18 – there will be no tax on the insurance proceeds.

Where the beneficiary is an adult child there potentially is tax payable at rates of up to 31.5 per cent on the death benefit.

Scholten says the actual cost of a life insurance premium through DIY super will be much the same as it would be outside super. The price will depend on the age of the fund member, how much cover is sought and whether premium will be “stepped” or “level.”

Stepped premiums increase each year, with the rate of increase becoming greater the older you get. Level premiums are fixed at a flat amount and will only be varied if the insurer makes a change to the general level of rates.

In the early years of a policy, level premiums will be more expensive than stepped premiums, but for those taking out cover over a longer term, a level premium may be the better option.

Other factors such as sex, smoking history and general health of the fund member being insured will affect the cost, especially for those seeking higher cover where medical checks are a requirement.

Scholten says a 50-year old male non smoker who opts for a stepped premium for $1 million of cover can expect to pay $1785 a year.

A death benefit can be taken as either a lump sum or an income stream by a financial dependant, says super specialist Daniel Butler of DBA Lawyers. Any death benefit from super includes the late member’s account balance plus any insurance, he says.

The way in which other types of life insurance are paid is not so simple.

In the case of total and permanent disability insurance, this can become complicated where the insurance is against the risk a member may no longer be able to work in their normal occupation. If the member can still work in another capacity, the fund will not be able to distribute the insurance proceeds to the member even though it may be entitled to collect the insurance.

With total and permanent disability cover, it is important to be aware of new definitions that will apply from July 2011. Premiums for insurance that covers specific occupations will no longer be fully tax deductible. Only premiums in respect of general occupations will be tax deductible.

For example, the super fund of a doctor who works as a surgeon won’t be able a claim a deduction for disability insurance that specifically protects them against not being able to work as a surgeon if they are still able to work as a general practitioner. The only deduction that can be claimed is protection against not being able to work as a general practitioner.

In other words, if a member is unable to do their normal job but still able to do another job for which they are qualified, their situation won’t meet the permanent disability definition. While the fund may receive some insurance, it can’t be distributed.

Butler notes that if it costs $7000 in premium payments to protect the doctor as a surgeon and $4000 to protect him as a general practitioner, only the lower premium can be claimed.

Similarly complex is insurance such as trauma cover, when an insurer pays a benefit to a fund if a member suffers a trauma such as a heart attack and survives this.

While the fund can receive the proceeds from the insurance cover, this must be held in the fund until the member is legally able to access their super. To access the proceeds a member must meet a “condition of release”.

Retirement from work with no intention of ever working again is the most common condition of release, as is turning 65.

Until a member who receives a trauma benefit also satisfies a condition of release, the fund cannot pay them the insurance. Premiums from trauma insurance are not tax deductible because this insurance is not included in specific provisions that give tax deduction for other forms of insurance.

Another form of insurance that should soon be tax deductible to a super fund under a coming change in the law is terminal medical condition cover, where at least a doctor and a specialist diagnose that a member who collects on this cover has less than 12 months to live. Such benefits can be paid to tax free to members.

Income protection or temporary disablement insurance that can pay you income can also be organised as tax deductible insurance through a DIY fund. Where this insurance is paid to a member the proceeds must be taken as a taxable income stream. One thing to watch with this cover, cautions Mr Butler, is any clauses in the policy that allow the insurer to reduce any payment if the member is also taking an income stream such as a transition to retirement pension from their super.

A quirk in income protection insurance through super is that the benefit is not limited to the 75 per cent of your income restriction that applies to this form of insurance outside super.

A fund can supplement income protection payments with other super up to 100 per cent the pre disability income that is being protected. The only condition is that the extra super payments don’t come from compulsory super contributions.

The Australian Financial Review