There is a lot of confusion out there when it comes to applying for life insurance. Should you do it through your super, should you do it outside super, what are the pros and cons of each? This can all get a little bit confusing and I often hear a lot of misconceptions as to what you can do and how you should do it.
So today I thought I would try to demystify the confusion and explain to you exactly what to consider when structuring your Life insurance.
Firstly, when it comes to life insurance there are typically four types of policies that you should consider. They are as follows:
- Life cover. Also referred to as Death cover, this policy will pay a lump sum benefit if you were to pass away or diagnosed with a terminal illness;
- Total and permanent disability (TPD). Pays a lump sum benefit if you were to become totally and permanently disabled and unable to ever return to work;
- Trauma cover. Also referred to as Critical Illness, this policy will pay a lump sum benefit if you were to suffer a severe medical condition. There are specified conditions which are covered under this policy; and
- Income Protection. This will pay you a taxable monthly benefit if you are unable to work due to accident, illness or injury.
Of the above policies, basic Life, TPD and Income Protection can all be funded through your super if you choose to. Trauma cannot as it doesn’t meet a condition of release under the SIS Act. To keep this as simple as possible, I won’t get into the intricacies of the SIS Act, just know that it can’t be funded through super.
Of the three policies that can be funded via super, is this the best way to structure the cover? To answer this question there are a number of things you need to take into consideration.
Obviously, you have to consider that premiums will have a negative impact on your retirement savings if funded through super. Now you can generally make additional contributions to account for this, but you have to ensure you work within the superannuation contribution cap limits.
Alternatively, if you fund the policy outside super, you need to make sure you have ample cash flow to meet the premium obligation.
But these are obvious considerations. Let’s dive a little deeper and have a look at the tax implications as well as the restrictions on benefits. To do this we need to look at each cover individually as they all have their own set of intricacies.
When structuring your Life cover it is important to consider the tax implications from a premium deductibility perspective and the potential tax payable on the payment of a benefit.
If you own the Life cover in your personal name, you cannot claim the premium as a tax deduction. If a claim is made on the policy, and a benefit is paid, it will be paid tax-free regardless of who you pay the benefit to.
If you own the policy through super, your super fund will be able to claim a tax deduction. As the superannuation tax rate is 15%, this essentially means you get a 15% discount on the premium – which is great! The downside of funding Life cover through super is that there is potentially tax payable upon payment of a benefit.
If a payment is made through super the benefit will form part of your superannuation death benefit and taxed according to whether or not the beneficiary is a dependent or non-dependent for tax purposes. Now this is a very complex area and I previously put out a blog called “Payment of death benefits from superannuation | Estate planning in Australia” which covers it in detail. But, in a very broad summary, the following people can receive the benefit tax-free if paid via a lump sum:
- Spouse (inc. de facto partner) or former spouse;
- Child, aged less than 18;
- Any other person with whom the deceased person had an interdepency relationship with just before he or she died; or
- Any other person who was a dependent of the deceased person just before he or she died.
So, if you are intending for a Death benefit to go to one of these people, then owning the policy through superannuation is probably a good idea as you get a reduced premium due to the tax deduction. If you plan on the benefit being paid to a non-dependent, then you may want to consider funding the cover outside of super.
If you do run the policy through superannuation, just remember that super is a non-estate asset and in order for the death benefit to go to your preferred person you should have an appropriate death benefit nomination in place.
Similar to Life cover, if you own the policy in your personal name you cannot claim a tax deduction for the premium. If you own the policy via superannuation, your super fund can claim a tax deduction at the superannuation rate of 15%.
Also similar to Life cover, if you own the policy in your personal name you will receive the benefit tax-free. If you own the policy via super, there may be tax payable as you will need to withdraw the money as a lump sum from your super.
This is a complex area of advice as it depends on your age and the components that make up your super fund. Here is my best attempt at summarizing it without going into huge amounts of detail:
- There is no tax payable if you’re aged 60 or over.
- If you have met preservation age, but are below age 60, you can withdraw up to $215,000 tax free. If you withdraw more than this amount, the tax-free portion of your super fund will be paid out tax free and the taxable portion of your super fund will be taxed at 17% (inc. Medicare levy).
- If you are below preservation age, the tax-free portion of your super fund will be paid out tax free and the taxable portion of your super fund will be taxed at 22% (inc. Medicare levy).
To summarise, if you are below 58 years old then expect there to be some tax payable when you withdraw your TPD benefit from super!
In addition to the tax implications of TPD, you also need to consider the TPD definition you wish to apply for; any or own occupation.
An any occupation definition will pay out in the event you are unable to work in any role which you are reasonably suited given your education, training and experience. An own occupation is more specific and will pay out in the event you were unable to work in the occupation you held prior to the disability.
Super funds won’t allow you to hold an own occupation TPD policy through your super as it may not meet a condition of release under the SIS Act. You can only hold an any occupation definition through super.
Some insurers will allow you to have a hybrid policy where you can fund majority of the TPD cover through super under an any occupation definition then pay a small premium outside of super to hold the own occupation definition. This gives you the tax benefit of paying majority of your TPD through super while having the comfort of holding an own occupation definition.
Out of all the policies, Income Protection is the only one which you can claim a tax deduction for if you pay the premium personally. This means that provided you have the cash flow available, most people will be better off paying for Income Protection out of their own pocket rather than through super as the tax deduction will be at your marginal tax rate which is often higher than the superannuation rate of 15%.
You can fund it via super and make a tax deductible contribution to your super fund to cover the cost which, in-effect, will give you the same personal tax outcome. However, this will use up concessional contribution cap limit which could otherwise be used to boost your retirement savings.
If you make a claim on an Income Protection policy the benefit is taxed at your marginal tax rate regardless of whether you own it personally or via your super fund. Where there can be a big difference in Income Protection through super and Income Protection owned outside of super is in the ancillary benefits that comes with a policy.
If you have a comprehensive Income Protection policy you often get a number of ancillary benefits such as crisis recover benefit, specified injury benefit, counselling, accommodation, travel, etc. These benefits do not meet a condition of release under the SIS Act and therefore cannot be funded through super.
Again, there are insurance policies out there which will let you have a linked policy with majority of the premium payable inside super, for the core Income Protection benefits, and a portion payable outside of super for the ancillary benefits.
Alongside these ancillary benefits you also need to take into consideration the Income Protection’s waiting period, benefit period and definition of disability. These are all VERY important aspects of an Income Protection policy whether you are holding it inside or outside super.
Shop your cover around.
If you do decide to fund your insurance through super, many people are under the false pretense that you need to use the insurer offered by your super fund. This is a common misconception that I want to break.
Regardless of which super fund you are with, you have the ability to shop your insurance to find the most appropriate and cost-effective policy for you. The only thing that will change is how they take the money from your super fund.
If you go with the super funds “preferred” insurer, the premium will come out of the super fund like any other fund expense. It will simply be debited. If you choose a third-party insurer the premium will be funded via rollover.
This means, once per year, your insurer will lodge a rollover request from your super fund for the amount of the premium. The good part is, you still get the 15% tax deduction, and this is actually given to you upfront when the premium is funded via rollover. The rollover amount will be the premium less the 15% tax deduction.
There are a couple of things to be careful of when funding the premium via rollovers. I have seen some super funds have a minimum rollover amount, although this is not that common, but the bigger consideration comes if you are making personal contributions into your super fund.
If you are making personal contributions into your super fund, and you intend to claim these contributions as a tax deduction, you will need to lodge a notice of intention to claim. This needs to be done prior to any rollover (including partial rollovers for insurance). If you fail to lodge a notice of intention to claim prior to the rollover being executed, you won’t be able to claim the full amount of your contribution.
When taking out insurance it is very important that you structure the policies correctly as this can have implications on not only the benefits you have access to but also tax implications. If after reading this, you still don’t have a clue what is best for you, then you should seek personal financial advice. Feel free to reach out and I will be happy to assist.