There is great appeal in housing life and permanent disability cover within a superannuation fund, primarily because premiums can be funded from retirement savings, sparing the client the burden of personally funding an expense that is not tax-deductible. However, when insurance is housed within super, an additional layer of complexity, as well as opportunity emerges.
This article highlights where some of these nuances arise, both at inception and following the occurrence of an insurable event.
Platform fund versus insurance-only fund
It’s well known that an upfront 15 per cent rebate may be accessible on the cost of life cover within an insurance-only fund, so long as the annual premiums are funded via rollover of super proceeds from an external fund. What is often overlooked, is that an equivalent 15 per cent tax benefit may equally apply if the insurance was instead housed within a platform retail super fund, or a self-managed super fund (SMSF).
It means that the decision to house cover within super, at least from a cost perspective, should be broadened beyond the insurance-only super fund option, especially given the net cost of the cover under both structures may be the same. Chart A (below) illustrates this point.
Consider the option of structuring your client’s life and Total Permanent Disability (TPD) cover via their existing platform super fund, rather than establishing a new account within an insurance-only fund.
The trustee of this platform super fund is the legal owner of the life and TPD policies, and holds the policies for the benefit of your client. The trustee will debit the relevant funds from your client’s super account and remit this to the insurer when premiums become payable. When the trustee debits the client’s super interest to pay the premium, it’s accounted for as a tax-deductible expense of the fund, which in turn reduces the assessable income of the fund during the relevant financial year. The ensuing reduction in the fund’s tax liability puts it in a position to pass back a tax ‘credit’ into your client’s super account, as it was the payment of the premium for the client’s cover that resulted in the lower tax impost within the fund.
So, the net cost of the cover within the platform fund may very well end up being 85 per cent of the ‘headline’ premium reflected in the quote; and the outcome would be the same if it had been structured in an insurance-only super fund and funded via partial rollover. It’s important to factor this into any decision to house life insurance cover within superannuation, especially when the natural tendency may be to favour the insurance-only fund structure offering an ‘upfront’ 15 per cent rebate on rollover. Some platform providers also offer further premium discounts, making the platform option an even more cost-effective vehicle.
Just be mindful of any timing differences, though. For example, how quickly does the trustee of the platform fund pass back the tax credit following payment of the premium? Additionally, some funds are accounted for at a group level, meaning the tax credit may be ‘socialised’ with other members of the fund, potentially diluting the credit in the pass-back process.
Chart A: Comparing cost of super-owned insurance cover
Benefit payment options expanded within insurance-only funds
Upon a successful claim, super-owned insurance proceeds are paid into the claimant’s super account. From there, the trustee must deal with the benefit in accordance with superannuation law and the governing rules of the fund.
For example, in the event a death benefit claim is approved, the fund trustee must pay the death benefit (which may or may not comprise of proceeds from a fund-owned life insurance policy) as soon as practicable to the nominated beneficiary, either as a lump sum or, if the beneficiary is eligible and the fund is setup to do so, an income stream.
Ordinarily, life insurance proceeds may be relied upon to pay down non-deductible mortgage debt. In such cases, a super lump sum cash payment would be directed to the nominated beneficiary’s bank account. If the beneficiary is a surviving spouse, the payment is received entirely tax-free.
But what if the sum insured on the recommended life insurance policy were set at a level that exceeded the prevailing amount owing on a mortgage? Perhaps these extra funds were intended to provide a pool of capital upon a premature death that the surviving spouse could count on, to fund ongoing family living expenses, in particular the school tuition fees of minor children.
Whatever the case, an assessment needs to be made before withdrawing death benefits entirely from the superannuation system. If part of the capital is not required for immediate withdrawal, then there may be merit in retaining part of the death benefit within the super system. A surviving spouse beneficiary can do this by commencing a death benefit income stream, subject to transfer balance cap rules.
Case study: Life cover
Your clients, Bob and Jane, are a married couple. They are both 45 years old. Both are employed in the medical profession and are on the top marginal tax rate. They have two children who are at primary school.
You originally met Bob and Jane a couple of years ago. As far as their wealth protection needs were concerned, you recommended they each take out life, TPD and income protection cover. Their objectives were to not only cover their high levels of employment income, but also put in place lump sum insurance to enable a surviving spouse, in the event of a premature death, to be in a position to repay the mortgage and provide a pool of capital to fund the children’s future education fees, should either of them suffer from an insurable event.
Your recommendation was for $1.6 million of life and TPD cover to be placed within an insurance-only fund. Their mortgage is currently $1 million. Your calculations at the time of the initial advice determined that an additional $600,000 in life and TPD cover would be required to account for the tax payable on the TPD benefit, and meet their objective to establish a future education fund for the children.
Looking ahead to the trigger event
Should Bob suddenly pass away, as the nominated beneficiary of Bob’s super fund, Jane will take receipt of a $1 million lump sum payment into her personal bank account. Being a tax dependant of Bob’s, Jane receives this lump sum payment tax-free. The entire $1 million is used to immediately repay the home loan.
The trustee of the insurance-only fund will then need to deal with the remaining $600,000 in claim proceeds. As the beneficiary, Jane must instruct the trustee to either pay this amount to her as a lump sum or, if she wants to retain it within the super system, roll it over to another super fund to commence an income stream. Notably, she cannot invest these super proceeds within an insurance-only fund. Previously, the legislation precluded such a rollover, however, recent amendments to the tax law have enabled the transfer of super death benefits from insurance-only funds, so long as an income stream will be commenced (by qualifying beneficiaries) from the destination fund.
As many financial planners understand, there is considerable merit in retaining this $600,000 within the super system. The mortgage would have been fully repaid, and absent of any other immediate capital expenses, Jane may not need access to this capital right away. Despite being well under preservation age, the capital is a 100 per cent unrestricted non-preserved component, meaning she can take top-up (and tax-free) withdrawals/commutations from the pension account on top of the prescribed 4 per cent annual minimum pension payment. That could provide the cash flow to pay the school fees and fund other day-to-day or ad hoc living expenses.
The $600,000 purchase price will trigger a credit within her transfer balance account, but given she will not have an existing ‘retirement phase’ income stream, Jane will have a full transfer balance cap to work with. Of course, having such a large pool of capital sitting within a tax-free pension bucket is likely to provide a much more tax-effective way of investing the funds, and avoids any personal income tax that she may have otherwise paid if the $600,000 were instead invested in her own name.
As an alternative to the death benefit pension option, you may have queried whether the $600,000 should have been directed into a testamentary trust via Bob’s estate. While certainly possible, the terms of the testamentary trust needed to have been built into Bob’s will during his lifetime, which would have required forward planning and introduced more costs into the advice process.
While the trust is an option worth considering, for clients with relatively simple affairs and more modest estates (such as Bob and Jane), arguably similar if not superior outcomes may be achieved by retaining a super death benefit via a death benefit pension. Subject to the application of notional estate provisions within the respective jurisdiction, it may also remove the risk of the benefit being challenged via the estate, as the capital must pass through the deceased’s estate before settling the testamentary trust.
Extending the case study: TPD cover
If Bob were to suffer from a permanent disability, he could look to roll over the $600,000 to his existing super fund and, if desired, commence a fully accessible super disability income stream. Prior to rolling over, the trustee of the insurance-only fund should apply the tax-free component modification under s307-145 of the Income Tax Assessment Act 1997. That ensures his super balance is afforded a tax concession to recognise his permanent incapacity and inability to resume work.
The upfront 15 per cent rebate via an insurance-only fund has appeal, but a comparable 15 per cent concession is likely to be available if cover is instead housed within a platform fund or SMSF. Beyond these cost considerations, financial planners should consider what the client’s objectives are and how these will shape their strategic advice following a claim.
In many cases, there will be merit in retaining insurance proceeds within the super system, and the options are now greater, given the ability to roll over death benefits from insurance-only funds to a platform fund or SMSF, to commence a death benefit pension.
Benjamin Martin, Senior Manager – Product Technical, Life Insurance, BT.
1. What makes insurance in a platform super fund potentially equivalent in cost to that of an insurance-only super fund?
Platform funds have the reversionary pension option.
Platform funds are APRA regulated.
Platform funds can generally pass back a 15 per cent tax credit into the life insured’s super account.
Because the platform fund meets the wholesale investor criteria.
2. A needs analysis reveals that Freddy (45 years of age) needs $2 million in super-owned life insurance cover. This is to protect his family from his premature death and enable his spouse (44 years of age) to repay the $1.2 million mortgage debt and provide $800,000 in seed capital for the future education costs for their two young children. Assuming Freddy were to prematurely pass away tomorrow, with regards to finding a vehicle to house the $800,000 seed capital, which of the following statements is false?
His spouse may be able to retain the $800,000 inside the super system via the commencement of a death benefit pension, with full access to the capital.
His spouse may be able to retain the $800,000 inside the super system via the commencement of a death benefit pension, however, it will be a ‘preserved component’, given she is under preservation age.
His spouse may be able to retain the $800,000 inside the super system via the commencement of a death benefit pension – it would count as a credit towards her transfer balance account.
The $800,000 could be paid as a cash lump sum directly to the surviving spouse – it would be paid entirely tax-free.
3. Insurance-only super funds are not able to pay death benefit pensions, however, the trustee of such a fund can roll over the death benefit to another super fund for the purposes of commencing a death benefit pension. True or false?
4. Directing a superannuation death benefit into a testamentary trust may be a suitable option, particularly if:
The beneficiary cannot retain part of a death benefit within super due to transfer balance cap and super law limitations.
The client has structured their estate so that a testamentary trust can be activated by executors on death.
The investment of that capital within the hands of the intended beneficiaries is likely to create tax inefficiencies.
All of the above.
5. You’re overseeing an $800,000 superannuation death benefit claims process following the premature death of one of your clients. Despite not having any immediate capital expenditure needs, your deceased client’s widow (47 years of age) wants to withdraw the entire death benefit from the super system and ‘park’ the proceeds within her bank account. Which of the following statements is correct?
Given there is no immediate need for the capital, we could consider retaining the funds inside super via the commencement of a death benefit pension while retaining full access to the capital going forward.
We can withdraw the super lump sum now, then if required at a later time, recontribute the funds back into super and immediately commence an income stream.
We can simply amalgamate the $800,000 with the widow’s existing personal superannuation savings, and keep it in there indefinitely.
We can request an $800,000 lump sum death benefit and collect an anti-detriment payment along the way.
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