This article considers how to claim tax deductions when insurance is held within superannuation.

From a super fund trustee perspective, one of the main benefits of offering life insurance within a super fund is the ability to claim tax deductions for any insurance premiums paid for death and disability cover.

However, another tax deduction may be available to the super fund if the trustee chooses not to claim a deduction for the premiums paid, but instead claim a deduction for the future liability to pay death or disability benefits. This can potentially allow the super fund to claim a much higher deduction overall.

Under section 295.460 of the Income Tax Assessment Act 1997 (ITAA 1997), a tax deduction may be claimed by a trustee of a fund for premiums paid, or a future liability, because of cover for:

• death or terminal illness;
• total and permanent disability (disability super benefit); or
• income protection.

Claiming tax deductions when insurance is held within super

Under section 295.465 of ITAA 1997, when insurance is held within super, premiums paid may be tax deductible to the super fund.

Term life insurance held within superannuation is generally 100 per cent tax deductible to the fund.

With total and permanent disablement (TPD) insurance cover, premiums are only deductible to the extent that the TPD insurance definition meets the ‘disability superannuation benefit’ definition in the Tax Act. The definition of a ‘disability superannuation benefit’ requires that the person is unlikely to ever be gainfully employed in a capacity for which they are reasonably qualified because of their education, training or experience.

If a super fund holds any occupation TPD insurance that is aligned to the definition of a disability superannuation benefit, then the premiums are 100 per cent deductible to the fund.

Own occupation TPD and trauma insurance (sometimes referred to as ‘living insurance’) could only be taken out within super before 1 July 2014. Where this type of insurance was taken out prior to 1 July 2014, the super fund can thereafter continue to hold the insurance within the fund, and also increase or decrease the sum insured, when required.

For pre-July 2014 standalone own occupation TPD policies inside super, premiums are 67 per cent deductible, as the policy may provide some benefits which do not meet the definition of a ‘disability superannuation benefit’. If own occupation TPD cover is linked to a Term life policy, premiums are 80 per cent tax deductible to the trustee. Trauma insurance premiums are not tax deductible.

When holding income protection insurance within superannuation, a full tax deduction can be claimed for the premium, provided the proceeds are intended to be paid in accordance with the temporary incapacity condition of release.

Future liability tax deductions

In the event of a client passing away or where they need to claim for a disability, the fund may be able to claim an alternative tax deduction for the future liability to pay a benefit.

In the case of a payment of a death benefit, terminal illness or TPD benefit (disability super benefit), the alternative election is only available where benefits are paid as a consequence of the termination of a client’s employment. This includes termination as an employee or a self-employed person.

In the case of temporary incapacity, the client must be unable to be engage in gainful employment due to sickness or injury.

To be eligible to claim the future liability tax deduction, the fund must have paid an insurance premium in that year, as demonstrated by private binding ruling 1012057834929; that is, the fund must have been in a position to claim a tax deduction for insurance premiums paid, to then be able to elect to use the future liability tax deduction.

This deduction is available to all super funds, but public offer funds don’t usually utilise the tax deduction for premiums paid. However, clients with their own self-managed super funds (SMSFs) could consider applying for the future liability deduction.

Calculating the future liability tax deduction

The amount of the future liability tax deduction is calculated as:

Benefit amount x Future Service Period / Total Service Period

The benefit amount is the amount of the lump sum paid, or the value of a pension payable. In the case of temporary incapacity, it is the total amount paid during the year of income.

Future service days are the number of days from the date of termination to the client’s last retirement day (usually age 65). In the case of temporary incapacity, it is the day the client ceased gainful employment and ends on the last retirement day (usually age 65).

Total service period is the number of days from the start of the eligible service period until the client’s last retirement date.

Election to claim the future liability deduction

To claim the future liability deduction, the trustee of the superannuation fund must make an election to not deduct amounts based on the premiums paid in the year in the event of a client passing away or where they need to claim for a disability, and instead, claim for the future liability to pay benefits.

The trustee can claim deductions based on the premiums paid up to the year the benefit is paid and, in the year that the insurable event occurs, elect to use the future liability tax deduction then.

The future liability election applies to all future years unless otherwise determined by the Commissioner of Taxation.

When should a fund consider claiming this deduction?

The future liability tax deduction does not increase the benefit paid by the super fund in the event of a client passing away or when a disability benefit is paid.

It provides a tax deduction to the fund which can be used to offset tax in the year the event occurs, or in future years. If tax losses are created by using the full tax deduction in one year, the remaining tax deduction can be carried forward to reduce assessable income in future years.

This provides an overall benefit to all remaining members of the SMSF, as the deduction may reduce current and future tax liabilities, and therefore effectively increase balances. If these members hold benefits in the accumulation phase, there is likely to be future income tax and capital gains tax (CGT) that can be offset by the remaining future liability tax deduction.

As the benefit may only be fully realised if the fund continues, it may not be beneficial for a fund to claim a future liability deduction if the fund is soon to be wound up. However, if a CGT event will be triggered upon assets being sold in the process of winding up the fund, then this deduction could potentially offset the CGT, if the full tax deduction is used.

The following case studies illustrate how the future liability tax deduction may apply in different scenarios.

following case studies illustrate how the future liability tax deduction may apply in different scenarios.

* The figures in the case studies are approximate and have been calculated based on the number of years, instead of the number of days, for simplicity.

Conclusion

Where an SMSF meets the criteria to be able to claim a future liability tax deduction, it may be worthwhile for the trustee to consider whether it is best to claim the future liability tax deduction or claim the premiums as a deduction in that year.

As with any strategy involving tax law, SMSF trustees need to seek individual tax advice before using this strategy. However, when deciding which deduction to claim, super fund trustees could consider:

• The age of the members – the younger the members are when they claim the insurance, the higher the future liability deduction will be (as they will have more future service days).
• Whether or not the insured person is working when they become disabled or die (as they will need to terminate employment if in the event of a death, terminal illness or TPD payment).
• Whether there will be any future members of the SMSF, and how long they will remain in the fund.
• If the members are in accumulation phase or pension phase – if all the members will be in pension phase, future tax deductions will not be beneficial to the fund, as earnings on assets underlying the pension are received by the fund tax-free. However, with the introduction of the transfer balance cap, it is more likely that members will have some proportion of their super in the accumulation phase.
• If an income protection benefit is paid, the future liability deduction may be less than claiming the insurance premiums in that year. Even if the future liability deduction is greater, it may not be worth missing out on claiming future premium deductions.

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QUESTIONS

Take the quiz here

1. When trauma insurance is held within super:
   1. The super fund can claim a tax deduction for the cost of the premiums.
   2. The super fund can only claim a tax deduction for the cost of the insurance if the trauma cover has been held in the super fund prior to 1 July 2014.
   3. The premiums are never tax deductible.
   4. The premiums are not tax deductible but the fund could claim a future liability tax deduction if a trauma benefit is paid from the fund.

2. A future liability tax deduction may be claimed against:
   1. Trauma and income protection benefits.
   2. Death, terminal illness, TPD and income protection benefits.
   3. On death benefits but not terminal illness benefits.
   4. Death and TPD benefits only.

3. A superannuation fund can only claim the future liability deduction if:
   1. The member of the fund who dies or becomes disabled was not working at the time the benefit was paid.
   2. The super fund also claims a tax deduction in that year for the cost of insurance.
   3. In the case of income protection benefits, the affected member ceases work permanently once they are disabled.
   4. In the case of death or TPD, the relevant member receives a benefit due to ceasing employment.

4. The future liability tax deduction is calculated as:
   1. Benefit amount x (future service days / total service period).
   2. (Benefit amount / future service days) x total service period.
   3. Future service days x (benefit amount / total service period).
   4. Benefit amount x future service days.

5. If tax losses are created from claiming the full future liability tax deduction in the current year:
   1. The fund will lose the ability to use the excess tax deduction.
   2. The fund can carry forward the excess tax deduction to offset any taxable income in future years.
   3. The fund can carry forward the excess tax deduction but only use it to offset capital gains tax in future years.
   4. The fund can carry forward the excess tax deduction but can only use it to offset taxable income in the next year.