In November last year, Parliament passed legislation to implement the Federal Government’s controversial superannuation reforms. The reform package was announced in the 2016-17 Budget and had been amended following a period of extensive consultation.

This article is for educational purposes only and is no longer available for CPD hours.

Advisers who provide insurance advice will need to properly understand the impact of these measures, both when making new recommendations on superannuation policy ownership, and reviewing advice to existing clients with insurance cover inside super.

The legislation covers the following superannuation initiatives:

• introducing a $1.6 million transfer balance cap;
• lowering the annual concessional contribution cap to $25,000;
• widening the scope of tax deductions for personal contributions to employed persons;
• lowering the threshold at which high income earners pay additional contributions tax (Division 293 tax) from $300,000 to $250,000;
• catch-up concessional contributions;
• lowering the annual non-concessional contribution cap to $100,000;
• allowing death benefits to certain beneficiaries to be rolled over to commence a pension;
• removing the anti-detriment payment benefit;
• removing the tax exempt status of earnings within transition to retirement income streams;
• increasing the thresholds for the spouse contribution tax offset; and
• introducing a Low Income Superannuation Tax Offset (LISTO).

The Government will also seek to enshrine the objective of superannuation.

The provision of life insurance advice will almost always require consideration of policy ownership. For individuals, this will normally require a decision to be made between superannuation and non-superannuation, or a combination of both. Depending on a client’s circumstances, some of these measures may influence the decision to establish a new (or maintain an existing) life insurance policy within superannuation.

In this article, we individually consider the measures which are most significant to insurance advice.

$1.6 million superannuation transfer balance cap

For many clients, the $1.6 million cap on pensions is the measure which will most significantly affect their insurance arrangements. From 1 July 2017, a $1.6 million lifetime cap (called a transfer balance cap) will apply on the total amount of accumulated superannuation an individual can transfer into the retirement phase. Importantly for life insurance strategies, this will include a death benefit pension received by a beneficiary.

An exemption applies for pensions commenced with contributions from a structured settlement for personal injury, but this does not include proceeds from a life insurance policy. The rules are also modified for child pensions; while not simple, the good news is that a child pension will not generally affect a child’s transfer balance cap when they become an adult.

In general terms, when a person commences a pension, they will establish what is known as a transfer balance account – this account is subject to the cap. Amounts credited towards an individual’s transfer balance account include existing pension balances as at 30 June 2017 and pensions commenced from 1 July 2017 (including reversionary pensions).

Insurance policies held within accumulation phase, which are subsequently transferred into a pension (or death benefit pension), will therefore count against the individual’s (or beneficiary’s) cap. Subsequent commutations from pension accounts will reduce a person’s account balance.

Amounts in the transfer balance account that are in excess of the transfer balance cap will need to be withdrawn from the superannuation system, or rolled back to accumulation phase. In the case of a death benefit, however, excess amounts can only be taken as a lump sum. This is because the legislation that requires a death benefit to be ‘cashed’ (i.e. taken as a lump sum or pension) has not been modified.

Example

Adrian (aged 48) has $800,000 in accumulation phase that holds his term life insurance policy (with a total and permanent disability rider) of $1 million. He dies in March 2018 and has nominated his spouse, Hannah (aged 46), as the sole beneficiary of his death benefit. The maximum amount that Hannah can elect to take as a death benefit pension will be $1.6 million. She must cash out the remaining $200,000 as a lump sum – which will be tax-free to her as a spouse.

Importantly, however, this will mean that (unless subsequent commutations reduce her transfer balance account) Hannah will be unable to commence a pension with her own superannuation balance when she eventually retires. This is because she has used up her transfer balance cap. Any indexation in the general transfer balance cap will only apply to the unused portion of her cap, which in this case is nil.

Notwithstanding the introduction of this cap, any lump sum death benefits are still tax-free to certain dependant beneficiaries, meaning superannuation ownership can still be a very powerful strategy. Advisers will simply need to be aware of the limitations, if any, resulting from the cap.

Where the life policy is for the benefit of children and a child pension is intended, advisers will need to consider a number of factors, including the number of children, whether the parent has an existing pension (or previously commenced one), and how much of the benefit is intended to be paid as a pension.

Generally, where the deceased parent did not have a transfer balance account (e.g. never commenced a pension), the child will be allowed to receive a death benefit pension up to the general cap of $1.6 million (2017/18). For multiple children, however, this cap is divided equally among the children. This would mean that four children would each be able to commence a death benefit pension up to a maximum of $400,000 (2017/18). The remainder would need to be cashed as a lump sum.

The rules, however, are entirely different where the parent had a transfer balance account. The cap that applies to each child will be the proportion of the parent’s super interest that was in pension phase, which is subsequently paid to the child as a death benefit pension.

The deceased parent will have created a transfer balance account if they had an existing pension, or had previously commenced one which was subsequently exhausted. In this scenario, a child pension can only be paid from an existing balance in pension phase, and not from accumulation phase (unless the child has an unused cap from the death of another parent). An insurance policy in these circumstances is attributable to the parent’s accumulation phase interest, and could therefore only be paid to the child as a lump sum, albeit tax-free.

A child’s ‘modified’ transfer balance cap will cease upon the child pension ceasing, i.e. at age 25, or when the balance is exhausted. Upon the child commencing their own pension at a later date, a second transfer balance will apply that will be subject to the normal rules discussed above.

For individuals generally, where a person has exceeded their cap, the super fund trustee will be directed and required by the Australian Taxation Office (ATO) to commute the excess amount. An individual will have the option to transfer any excess amount back to the accumulation phase (unless receiving a death benefit), or withdraw a lump sum (if they meet a condition of release).

Reduction in the concessional contributions cap

From 1 July 2017, the annual cap on concessional super contributions will be reduced to $25,000 – currently $30,000 for those under age 49 at the end of the previous financial year, and $35,000 otherwise (2016/17).

The reduction in the concessional cap may affect individuals who have insurance policies structured through super and are close to or have reached their concessional limit.

It is also worthwhile to note that employed individuals with income exceeding $206,480 (the maximum contribution base for 2016/17) would be receiving at least $19,616 in compulsory super contributions (super guarantee) this year – only $5,384 below the looming $25,000 cap. This margin will be even less from 1 July 2017 (when the maximum contributions base increases), leaving little room for additional contributions to fund retirement savings and/or insurance.

Claiming a tax deduction on personal super contributions to employed persons

Currently, to claim a tax deduction on a personal superannuation contribution, a person must (among other criteria) earn less than 10 per cent of their total income from employment. This rule means that those who are mostly self-employed, but earn 10 per cent or more of their income from employment, cannot make personal deductible contributions. Additionally, those who want to increase concessional contributions, but work for an employer that does not offer the ability to salary sacrifice, are disadvantaged.

From 1 July 2017, this rule will be removed, allowing access to tax deductions on personal superannuation contributions to all individuals, regardless of the level of income derived from employment (assuming all other criteria are satisfied).

One of the main advantages of structuring insurance through super is the ability to make concessional contributions into super, thereby reducing personal taxable income. Concessional contributions are generally subject to tax at 15 per cent upon entry into the fund, however, this can be offset by the tax deduction available to the fund for payment of insurance premiums, making the strategy tax-effective both at the individual and fund level.

For clients who currently break the 10 per cent rule, or employee clients who cannot salary sacrifice, the measure will make it easier to support super-owned policies in a tax-effective manner. It will also make it easier for employee clients to maintain insurance-only super policies through contributions, as salary sacrificing an exact premium amount can often be problematic.

Lowering the ‘30 per cent tax’ threshold

From 1 July 2017, the income threshold at which an additional 15 per cent tax is levied on concessional superannuation contributions will be lowered from $300,000 to $250,000.

This additional tax, known as Division 293 tax, applies when a person’s income, plus certain super contributions, exceed $250,000. It applies to the amount of concessional contributions in excess of $250,000, but does not apply to excess concessional contributions. A client who incurs this tax will have the option of paying it either directly or from a nominated super fund.

This measure may affect high income individuals who make concessional contributions to fund their premium payments. For those on the top marginal tax rate of 47 per cent (2017/18, including Medicare levy), paying 30 per cent tax on contributions still represents a 17 per cent tax saving.

However, this tax benefit, enjoyed while holding the policy, needs to be weighed against potential tax liabilities on death or disability payments from the superannuation fund. This is especially true given the abolition of the anti-detriment payment (discussed below) and the introduction of the transfer balance cap.

Catch-up concessional contributions

Individuals with super balances of less than $500,000 on 30 June in the previous financial year will be able to utilise unused portions of one or more of the previous five years’ concessional contribution caps.

As unused cap amounts will only begin to accrue from 1 July 2018, the earliest that any unused cap amount can be used is in the 2019/20 financial year. Unused cap amounts will operate on a rolling five-year basis, where they are used from the earliest to latest year.

An individual’s super balance includes their accumulation account balances, pension transfer balance, and rollovers in transit.

This will allow individuals with fluctuating work patterns to make additional concessional contributions, in excess of the annual cap (likely to be $25,000 in 2019/20), without incurring the excess concessional contribution charge, or impacting the non-concessional contribution cap.

The measure will mainly benefit women and carers who engage in part-time work or are periodically absent from the workforce. It will allow individuals to increase their super balance more rapidly than they would if restricted by the standard annual concessional cap, while still taking advantage of the tax concessions available when funding insurance inside super.

Non-concessional contribution changes

From 1 July 2017, the annual non-concessional contribution cap will be reduced from $180,000 to $100,000, with modified bring-forward provisions still available, dependent on the superannuation balance at the end of the previous financial year.

In addition, non-concessional contributions can only be made by individuals with total superannuation balances of less than $1.6 million (indexed). This restriction does not prevent balances from exceeding $1.6 million through non-concessional contributions; rather it determines whether an individual is eligible to make any non-concessional contribution in a particular year.

These measures may impact the attractiveness of insurance inside super for certain individuals, especially where they are relying on the ability to make non-concessional contributions to support their superannuation assets for retirement.

Further, where disability claim proceeds are paid from a super owned policy, the strategy of withdrawing and re-contributing these proceeds back into super will be significantly limited. This strategy was sometimes employed to achieve greater tax effectiveness when subsequently commencing a pension; or where a death benefit was expected to be paid to a non-tax dependant, such as an adult child, at a later date.

The measure will also make harder the use of insurance to provide liquidity to SMSFs.

With ATO pronouncements in 2014 preventing cross insurance arrangements within an SMSF, some members (with lower liquidity needs) have been able to solve liquidity problems by cross-insuring outside of the fund, and making non-concessional contributions from the insurance proceeds to provide the required liquidity. A lower non-concessional cap will, for many SMSFs, make this particular solution unworkable.

Death benefits

To facilitate choice of provider for beneficiaries, the legislation has been amended to allow a super death benefit to be rolled over (where a beneficiary is eligible to receive a pension) and not be treated as a contribution to the receiving fund.

This change will bring great flexibility to certain beneficiaries, who will be able to choose their death benefit pension provider, or access a death benefit pension if the deceased member’s fund does not offer one. Importantly, however, these rules will not change the fact that a death benefit cannot be retained in accumulation phase. Any amounts rolled over to another fund will be required to be taken as a lump sum or pension from that fund.

Anti-detriment provision

The tax deduction available to superannuation fund trustees to offset the anti-detriment amount will no longer be available for death benefits paid, where the individual dies on or after 1 July 2017, or the payment is made after 1 July 2019.

Currently, SMSF trustees may, if structured correctly, utilise insurance to provide funding for the anti-detriment payment, to alleviate cash flow issues in the period between payment of the anti-detriment amount and receipt of the tax deduction. This strategy will now become redundant. The trustee could still make an additional payment upon death that is funded through insurance, however, this would be akin to a standard insurance inside super arrangement.

More broadly, the removal of the anti-detriment provisions will need to form part of the overall tax analysis, when deciding between super and non-super ownership of a life policy.

Enshrinement

Although part of the overall package of superannuation reforms, a separate bill will seek to enshrine the primary objective of the super system in law, and require that any future bill or regulation relating to super is compatible with this objective.

The proposed primary objective of the super system is to “provide income in retirement to substitute or supplement the Age Pension”. This means that the role of the super system is to help individuals support themselves by providing income to meet their expenditure needs in retirement.

From an insurance advice perspective, the requirement that all future law is aligned with a primary objective, will provide comfort to many clients on the sustainability and stability of super as an ownership structure in general.

Summary

The reforms will clearly make super-owned insurance more attractive for certain clients (especially those with fluctuating work patterns), and less attractive for others.

These reforms have been the subject of significant debate, and public awareness about them is generally high. This will give proactive advisers an opportunity to better engage with new and existing clients on the reasons for a particular insurance recommendation in the context of this big news item.

Brendan Bowen, Product Technical Manager, Life Insurance, BT.