Michael Forer
Technical

Super Insurance vs Non-Super Insurance

By Michael Forer, Technical Services Consultant

Advisers face the ongoing dilemma of whether insurance should be owned inside or outside of superannuation (super). There are many issues to consider when determining the most appropriate ownership structure, including cash flow, taxation, estate planning, cost of premiums and ease of administration.

As you are no doubt aware, there are major benefits to owning insurance within super (summarised below). These benefits make it imperative that insurance within super is at least considered for every client, however, every client’s situation is different so this will not always be the most appropriate ownership structure.

The benefits of owning insurance within super

1. Premiums come from pre-tax dollars

Premiums for life insurance held outside of super are generally paid with after-tax dollars.

However, where insurance is arranged inside a super fund there is the opportunity to pay premiums from pre-tax income (such as super guarantee contributions or as part of a salary sacrifice arrangement).

The self-employed can pay for premiums using proceeds from their concessional super contributions.

The benefit of paying a premium with pre-tax dollars is demonstrated below.

An adviser has recommended a client take out a life insurance policy with an annual premium of $2,000 and is deciding whether to own the policy inside or outside of super. Assuming the client is on a marginal tax rate of 31.5 per cent, the net cost of the premium is calculated as follows;

Policy owned outside super

  Amount $
Pre-tax income required $2,919.71
Tax payable @ 31.5% $919.71
Net income to pay premium $2,000.00

Policy owned within super

  Amount $
Salary sacrifice $2,000.00
Deductible Premium $2,000.00
Super Tax Payable $0.00

To pay the $2,000 premium if owned outside of super, the client will need to earn gross income of $2,919.71. To own the policy within super the client will only need to salary sacrifice $2,000 into super.

There are other factors to consider but in this case owning the policy within super results in a significantly lower net cost due to the fact that the premium is paid for with pre-tax dollars.

2. Cheaper premiums

The premiums paid by a super fund are often cheaper because the fund has access to group rates. This is likely to be the case for employer funds. The cheaper premiums may allow your client to increase their level of insurance to a more suitable amount that may be unaffordable outside of super.

3. Automatic acceptance

Some super funds will provide automatic acceptance of insurance with no underwriting required. This can be extremely beneficial for clients who may have an existing medical condition and may therefore not meet the underwriting requirements should automatic acceptance not apply. Automatic acceptance of insurance can also save considerable administration time and costs.

4. Reduction in the super fund’s taxable income

Deductibility of insurance premiums from a super fund’s perspective is governed by sections 295 to 465 of the Income Tax Assessment Act 1997 (Cth). Premiums paid in respect of the following benefits are deductible to the super fund:

(A) a superannuation death benefit;

(B) a disability superannuation benefit; and

(C) a benefit consisting of an amount payable to a person under an income stream because of the person’s temporary inability to engage in gainful employment.

Note that income protection may also be deductible to an individual if the policy is owned personally. The tax deduction at the individual’s marginal tax rate will potentially be greater than the deduction to a super fund.

However, if a self employed person makes a deductible, concessional contribution and pays for the income protection policy in their super fund, the effective tax deduction will be the same as owning the policy outside of super.

5. Tax effective payment of benefits

Death benefits

With the abolition of reasonable benefit limits from 1 July 2007, life insurance proceeds paid out from super/pension are tax-free if paid to a dependant as a lump sum.

Provided either the deceased or the recipient is aged 60 or over, benefits paid in the form of an income stream will be tax-free, (with the exception of any untaxed element, which will be included in assessable income and a 10 per cent rebate applied).

If both the deceased and beneficiary are under age 60, the taxable pension income will be included in the beneficiary’s assessable income, but subject to a full 15 per cent rebate on the taxed element.

However, insurance proceeds paid as a lump sum from a super fund to a non-dependant will be taxed at 15 per cent on the taxed element, and 30 per cent on any untaxed element.

TPD benefits

Where the member meets the superannuation permanent incapacity rules, a lump sum withdrawal will qualify for a tax-free component. A TPD insurance lump sum received within super will be included in this calculation. The tax-free component of a permanent incapacity lump sum is calculated as a follows:

TPD Benefits

‘Days to retirement’ is the number of days from the day in which the person stopped being capable of being gainfully employed up to their retirement day (usually age 65). ‘Service days’ is the number of days in the members eligible service period.

After calculating the tax-free component, the remainder of the lump sum will then form the taxable component and be taxed according to the member’s age.

Alternatively, if a member elects a pension rather than a lump sum, the taxable component of the ongoing pension payments is taxed at marginal rates (less a 15 per cent tax offset) until the member’s 60th birthday when the pension will become tax-free.

Income Protection

Income protection payments will be assessable income in the hands of the member regardless of whether the policy is owned inside or outside of super.

Summary

There are many factors to consider when recommending insurance and ownership is just one of these considerations. Super will not always be the best structure in which to own insurance, but it should always be considered due to the significant benefits listed above.