Beating the Superman syndrome

The news for SMSF trustees without insurance in place is you're no longer invincible. You must examine having cover in place after July 1.

PORTFOLIO POINT: For very good reason, there’s a new mandatory requirement for SMSFs from July 1.

In the enthusiastic rush to start your own self-managed super fund, there are countless mistakes that can be made.

Thankfully, most of them aren’t disastrous. They are more of an annoyance.

Messing up ABN and TFN documents, choosing the wrong type of trustee for your situation (corporate/individual) and failing to correctly set up trading platforms and bank accounts can cause, to varying degrees, piles of extra paperwork.

Probably the biggest mistakes that can be made in setting up your fund regard insurance. And the potential consequences can be a million times more costly, literally.

(However, today’s column doesn’t apply just to SMSFs. It applies to any time you are moving, or consolidating, any superannuation account/s.)

Insurance is there for when the unthinkable happens – predominantly death and serious disablement.

And it appears that most SMSF trustees believe they’re Superman, and that bullets bounce off them. Just 13% of SMSFs, according to recent statistics, hold any insurance on behalf of members.

Sure, insurance is a “grudge” purchase. As a financial adviser, I get that. But just 13% of SMSF trustees have insured their members (and therefore their loved ones) in the event of their death? Seriously?

Boot on the other foot
From July 1, considering insurance as part of your investment strategy becomes mandatory.

That doesn’t mean that trustees will have to take out insurance for members. But you will have to note that you’ve taken their potential insurance needs into account.

Under the proposed legislation, trustees will need to consider the members’ insurance requirements as part of the fund’s investment strategy. Investment strategies are a legal requirement for all SMSFs. By noting in the investment strategy that insurance has been considered for members, the government is at least hoping to force you to think about it.

The focus of most new trustees when setting up their super fund is to deal with the investment side of things. They want to control investments themselves and/or reduce the costs of investment management of their super.

Insurance is generally not front-of-mind. But consider the following examples to understand how new trustees, in particular, can cause disasters by rushing past the insurance checkpoint, particularly for dependants.

And, more basically, understand this. If you are under 50 and have a wife/husband, a mortgage and/or dependent children, the likelihood is that you need insurance. It’s just that you might not understand those needs without having them properly explained to you.

Here are some examples of often-occurring insurance disasters.

Example 1: Sudden death
If a few weeks after you rolled over your industry fund super to your new SMSF, you died. You had the intention of organising insurance in the SMSF, but had not yet done so (or you had simply ignored it). In your old industry fund, you had a policy for life/TPD for $1 million, which got cancelled the moment the industry fund agreed to send a cheque to your new SMSF. Your family is now $1 million poorer and your super balance that will be paid to them simply isn’t enough at even $300,000.

Example 2: Recent serious illnesses
If you set up insurance 10 years ago with your employer’s corporate super fund. In recent years, you suffered a serious cancer. Without thinking too much about it, you opened a SMSF and rolled your corporate super across. The insurance cover was lost at rollover. And you now can’t get life insurance anywhere until you’ve been clear of cancer for five years.

Example 3: Losing automatic acceptance
If you work for an employer whose super plan includes an automatic $500,000 cover for life and TPD insurance that does not require underwriting. This is particularly useful because you have a serious illness that is difficult, expensive, or even impossible, to get insurance for. Making the decision to leave that fund completely should only be done after very careful consideration.

For an understanding of the types of insurance that are available, and which ones are available inside and outside super, check out this previous column.

Insurance and Super – Rule Number One
Never, ever, transfer super from one super fund to another without considering existing insurance benefits.

You might still make the same decision. But think it through. Do you need the insurance? Do you have existing insurance in your super fund? Has anything serious happened to your health in recent years? Is it cheap insurance that’s worth keeping?

If you do need insurance – and a financial adviser could be well placed to talk you through the issues here – then you need to take that into consideration before closing any super accounts. Once insurance is cut off inside most super funds, particularly where there was limited underwriting to put it into place, it’s gone. There’s little ability to get the insurance reinstated.

One recent example that I’ve seen involved a super member who was leaving an employer-sponsored super fund and being transferred to the “personal” division of that super fund. In the personal division, the fees were going to be higher, so the member decided to switch to another super fund with lower fees.

No consideration was given to the mandated insurance in the fund before the switch occurred. After the switch, the member tried to get insurance at the new fund. Unfortunately, the super fund’s insurer wasn’t prepared to take on the relatively serious illness, even if it is tightly medicated and under control, that the member had and declined cover.

Understanding the need for insurance to protect the family, the member sought insurance elsewhere. Because of her medical condition, the insurance is going to cost her roughly three times as much as the insurance she previously held.

The member had no choice. They needed the insurance. But they could have kept the insurance at the old fund.

The solution?
In this case – and the solution would fit many of the other examples listed above – it might have made sense to leave enough money in the first super fund to be able to pay for the insurance. By all means transfer most, if not all, of the super to another account (including your new SMSF), but leave some in the fund to pay for insurance for a few years.

If after a few years, you haven’t been able to get insurance on your terms and the balance is running down at the original super fund, money can always be transferred to the original super fund to make sure there’s enough money to continue to pay the insurance premiums.

Insurance contracts, even where it is offered without underwriting, as is the case with many industry and corporate funds, generally cannot be cancelled. In many instances, higher premiums might have to be paid. But, situation by situation, it’s often going to be better to pay for the insurance at the old super fund than to be refused cover, or to have to pay multiples of the previous insurance cost, in order to have adequate insurance cover.

Insurance and investment strategies
The point behind the new regulations is to get SMSF trustees to properly consider insurance, in the same way that the point of forcing SMSF trustees to have an “investment strategy” is to get them to put some thought into the risks associated with investing.

Your investment strategy is actually a living document. It should be reviewed on a constant basis, to take into account what you’re doing with the investments in your super fund.

It shouldn’t be something that you have to check before you make each and every investment. It is a document that should be reviewed once a year, but certainly no less than every two years.

You need to add to that now a section to say that you have considered the insurance needs of your individual members. Your answer might well be “they have no need” and you should justify that answer in your investment strategy. And you’ll have to justify that decision, if ever questioned.

But one thing is for certain. It is highly unlikely that only 13% of SMSF members require insurance to cover themselves and their families. And if this requirement forces people to consider it for the first time, it will be a seriously positive step forward for trustees.

  • Self-managed super funds need to prepare for regulations requiring regular updates to investment strategy, and DBA Lawyers warn this will mean a change in habits for many trustees. DBA says the current relevant regulation, 4.09(2), “only requires an SMSF trustee to formulate and give effect to an investment strategy”, whereas the new wording is to “formulate, regularly review and give effect”. While currently strategies are to be reviewed on an annual basis under most state frameworks, this may now be more frequent. “In certain cases such as where an SMSF is actively trading investments or dealing in derivatives, a review quarterly, half yearly or 'as needed’ could be appropriate,” DBA says.
  • A regulatory recommendation on when to close bank accounts if winding up an SMSF will be removed by the Australian Taxation Office from its publications. The ATO has clarified its advice “that a bank account must be kept open until confirmation of a fund’s wind up is received” will be removed. Instead, the ATO says: “Bank accounts can be shut once all expected final liabilities have been settled. In the case of tax liabilities, including the final SMSF levy, the liability can be prepaid or paid with lodgement.” An open bank account is not required to be maintained by legislation, but the ATO says one situation where this is required occurs if the fund is to receive a tax refund.
  • Property developers may be about to target SMSFs in greater numbers now that clarity is in place around the purchase of off-the-plan apartments or house-and-land packages. SMSF Academy head Aaron Dunn says that the initial draft ruling on limited recourse borrowing suggested loans could only be entered into for an off-the-plan purchase once the property had been completed and strata titled. But he says under SMSFR 2012/1: “Providing that the strata titled unit is a single acquirable asset, the deposit and the balance payable at settlement may be funded under a single LRBA.” Dunn says he expects property developers to be ready to take advantage of the implications of this final ruling.
  • The Australian Taxation Office says it is cracking down on early release schemes for SMSFs and illegal early access of funds. “Do not be tempted to set up a SMSF with the intent to access your super savings early,” the ATO warns. There have been several recent cases where offenders were penalised for this conduct, including one case that saw three trustees handed custodial sentences and hefty fines according to the ATO. “Not only are there significant tax implications for those concerned, large penalties – fines of up to $220,000 and jail terms of up to five years – could be imposed if you set up an SMSF and knowingly access your super illegally.”

The information contained in this column should be treated as general advice only. It has not taken anyone’s specific circumstances into account. If you are considering a strategy such as those mentioned here, you are strongly advised to consult your adviser/s, as some of the strategies used in these columns are highly complex and require high-level technical compliance.

Tags: insurance, superannuation, SMSF, trustees, investment strategies,

Bruce Brammall is director of Castellan Financial Consulting and the author of Debt Man Walking.

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