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Always look on the bright side of life... insurance inside SMSF

06 March 2013

When new regulations are introduced to a rapidly expanding sector, as they are in the world of self-managed super funds, they are often met with a groan as they spell change, new processes and increased management time. But of course the regulations are intended to protect one’s future financial wealth and once in a while they offer an opportunity to increase that wealth.

So it was with the announcement of new regulations in August 2012 that outlined the fact that SMSF trustees are now required to ‘consider’ holding insurance cover for fund members. I mentioned this in my August 2012 post. The Cooper Review of Australia’s superannuation system found that as few as 13 per cent of SMSFs hold a contract of insurance for the fund’s members. The new regulations do not mandate that members of SMSFs are insured through their fund, but they do create a legal obligation on the SMSF trustee to document the regular (most likely annual) decisions around insurance for members.

It’s a very reasonable request, and one that should be taken very seriously. After all, there are many potential financial benefits of insurance held within an SMSF.

Follow Regulations, Save Tax

Generally SMSFs can hold Term Life insurance, Total and Permanent Disablement (TPD) insurance and some Income Protection cover. If these are held within the SMSF then the fund actually owns the policies and the premiums must be paid from its funds. For many this will spell tax benefits. Let me explain.

Life and TPD policies, when owned and paid for personally, are generally not tax-deductible. But they generally are tax-deductible when paid from within an SMSF*. Tax paid by a properly set up fund can be reduced because an SMSF can claim tax deductions for taxes paid on super contributions that cover insurance premiums.

As an added bonus, to help pay the premiums and to make up for the fund dollars that go towards the insurances, a member may be eligible to make concessional, before-tax contributions into the SMSF. These could take the form of salary sacrifice or employer/personal deductible contributions, all of which can reduce the amount of tax a member may pay personally.

For a person on the highest tax rate who personally pays $2,000 annually in premiums for Term Life and TPD insurance (the actual before-tax income cost is $3,738), paying the premiums through a SMSF can represent a first-year personal tax saving of $1,738**. Plus, $2,000 of personal cash flow is freed up as it is now paid by the SMSF.

But Wait, There’s More

When a member of an SMSF dies, the fund has to pay a benefit to the deceased member’s beneficiaries. If much of the fund’s investments are tied up in large and relatively illiquid assets such as property, the asset may have to be transferred out of the fund or sold to make such a payment.

However, generally if the SMSF is structured in a particular way, then insurance proceeds received by the fund can provide the fund with the cash it needs to make this pay-out, keeping the major assets within the fund and avoiding a potential re-shuffle of investments. Similarly, in a well-structured fund the proceeds from Term Life insurance may be utilised to pay out loans on major assets, in the event of death or disability of a member.

Just remember to look into the regulations around in-fund insurance, including the fact that insurance claim proceeds will be paid to the SMSF and not to a member personally. To receive the insurance proceeds personally, the fund must also be satisfied that the member meets a superannuation condition of release.

In-fund insurance is one more example of how a self-managed super fund hands the control over to you, the fund’s trustee.

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* The exception to this rule is 'Own Occupation' TPD, which is only partially tax deductible within super.
** Assumes the policy is an 'Any Occupation' TPD policy and meets criteria to obtain 100 per cent deduction.

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.