In can be out in super insurance

PORTFOLIO POINT: Considering insurance inside your SMSF is now a must, but some ought to consider the alternative.

There have been so many changes, so many near changes and so many coming changes in superannuation recently that it’s a little hard to know what’s happening and when.

And, it would appear, there’s another nasty bunch coming, as I have raised in recent weeks (SMSFs in the firing line and The big super raid is on the way).

But there was one change that came into effect on August 7 this year that occurred with little fanfare. SMSFs now have to consider insurance for their members and include those deliberations in their investment strategy.

Importantly, the new rules don’t say that SMSF trustees have to take out insurance for members. Just that consideration must be given to doing so. Trustees may decide, on balance, that they don’t believe that the members need insurance. But they need to justify that decision.

Essentially, you need to write down your reasons for having insurance, or deciding not to have insurance, in the investment strategy (which is also a legal requirement of a SMSF).

(I’ll return to how you deal with the question of what to do if you’ve considered insurance, but have decided against it, later in this column.)

Contribution caps versus insurance in super

But the increasing tightening of contributions caps in Australia means that some SMSF trustees should reconsider whether inside super is where they should have the insurances they deem necessary.

Essentially, if you are trying to maximise your super and are easily affording to make contributions up to your concessional contribution limit of $25,000 – possibly $50,000 for you and your partner – and have the capacity to put in more if you were allowed, then super might not be the best place to have your insurances.

Insurance is an expense to the super fund. If you have two members and their necessary insurance premiums total, say, $5000-$10,000 a year, then you’re eating up 10-20% of your fund’s contributions in insurance premiums.

For example, $1 million worth of life and TPD cover for a 48-year-old female non-smoker in a SMSF would cost around $2200. A non-smoking 48-year-old male would have premiums of around $2500. Higher requirements of cover, or adding income protection (which I rarely recommend inside super because of the quality of policies), could easily take you to $8000 or $10,000 or beyond.

A significant issue is contribution caps. From July 1, 2012, all super fund members eligible to make concessional contributions have the same cap of $25,000. (Inflation will, eventually, lift that. But that’s where it is for now.)

Given that the tax deduction inside super is only 15% for those policies (and less if the total and permanent disability (TPD) policy contains an “own” occupation definition), then if wish to contribute extra to super one way of doing that might be to bite the bullet and pay for your life/TPD insurances outside of super.

“Okay, but what’s the trade off?”

Firstly, a tax deduction on the raw cost of the policy. A $3000 policy would soak up $3000 of your concessional super contributions (or would require a $3000 salary sacrifice). A $3000 out-of-super policy would require you to earn up $5607.50, if you’re on the highest marginal tax rate, as there is no tax deduction for life and TPD outside of super.

On the plus side, a TPD policy outside of super, if paid out, would have no tax payable on the proceeds. On the inside of super, if the policy is paid out to your super fund, you are likely to have to pay some tax.

When it comes to straight death cover in super, a member’s death benefit that is being left to a dependant will generally be paid out tax free. If it is being left to a non-dependant, it will be taxable. Outside of super, a life insurance payout is generally going to be tax free.

The tax issues are one thing and are the reason that so much insurance is (rightfully) done inside super funds, whether SMSFs or APRA-regulated funds.

But if maximising your super is critically important, then paying for your insurances outside of super might make sense.

Why have insurance inside super?

There can be very good tax and estate planning reasons for having your insurances inside super, particularly straight life insurance.

As covered in this column (Beware SMSF insurance traps), there are four basic types of insurance that can be held via a SMSF. For reasons set out in that column, we’ll ignore trauma cover today and focus on life insurance, TPD insurance and income protection insurance (also known as salary continuance insurance).

One significant reason for holding insurances inside super is that most premiums will be a tax deduction to your fund.

Life and TPD insurance inside super will generally qualify for a 15% tax deduction as an expense to the fund (“own” occupation TPD insurance does not qualify as a deduction for the “own” occupation portion of the cost of the policy). Life and TPD insurance held in your personal name does not qualify for a deduction and is, therefore, 15% more expensive.

Income protection will generally qualify for a tax deduction inside or outside a super fund. It will qualify for a tax deduction at 15% in your super fund, or at your marginal tax rate outside of your super fund.

Obviously, however, if you have it inside your SMSF, the cost of the policies are being borne by your future retirement funds. Spending your super on insurance means you’ll have less super.

Now, this can normally be overcome by adding extra to your super. If your policy costs $2000 a year, then salary sacrificing $2000 a year into your fund will mean that the insurances are paid for ... and more cheaply than the same level of cover outside super, where you would have to pay with after-tax dollars.

Also, any insurance that you pay for inside super is less of a drag on your personal cash flow.

But if you’re bumping up against the contribution cap limits, then you may want to consider insurance outside of super.

SMSFs and insurance – the new rules

From August this year, if you have a SMSF, you need to consider insurance. The rules don’t say that you have to have insurance. Instead, they say you must consider the following:

“Whether the trustees of the fund should hold a contract of insurance that provides insurance cover for one or more members of the fund.”

It has generally been regarded that trustees need to note these deliberations in the SMSF’s investment strategy.

Not everyone needs insurance. But the new ruling is designed to get you to think about it. If you’ve never thought about your potential need for insurance, then spending half an hour doing so could not be a bad thing.

If you have thought about it, but have considered everything and believe that you don’t need it, then it won’t take too much time to add it to your investment strategy and cover yourself in case of an audit.

The sorts of things that you need to consider in regards to insurance:

• Do the members have significant debts?
• What are the members’ net asset positions?
• Are there young children that have significant financial needs through to adulthood?
• How old are the members? How expensive would insurance be?
• What is the net worth of the members? Would net assets cover the financial needs of dependants?
• Do the members have insurance outside of super?
• What is the current health of members?
• Are existing assets enough to provide income streams for dependants in the event of the death/disablement of a member?
• Are the members retired? If yes/no, is income protection relevant?

That is not an exhaustive list but is designed to give you some questions to answer in your investment strategy.

Insurance is a highly technical area of financial planning. If you believe you might require insurance, see a financial adviser.

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 extremely complex and require high-level technical compliance.

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

• Australia has the third-best retirement savings system in the world, according to the annual Melbourne Mercer Global Pension Index released this week. Denmark overtook the Netherlands to take top place in the index’s global rankings, followed by Australia. Mercer senior partner and report author David Knox said Australia would edge closer to the top spot of the 18 countries included, thanks to the rising mandatory super contribution level. Knox said changes to the superannuation system that could improve it include introducing a requirement that part of the retirement benefit be taken as an income stream, and gradually raising the preservation age.
• The number and amount of excess contributions to super funds fell in the 2010-11 financial year, compared with 2009-10, according to the Australian Taxation Office. However, excess concessional contributions were still substantially higher than in the two prior years of 2008-08 and 2008-09. The ATO reported 31,217 excess concessional contributions-only assessments for the year, totally $85.7 million, down from 49,786, or $142.8 million, the year before. SMSF Academy head Aaron Dunn writes that people are continuing to predominantly get caught by concessional contributions, often through salary sacrifice, rather than non-concessional excess where there are only a few thousand cases. “The newly introduced ‘one-off’ refund of concessional contributions will appear to get a heavy workout in its first year of operation (2011-12) based on current statistics!” Dunn writes.
• An automated process for obtaining share registry data for SMSFs has been launched, in a partnership between BGL Corporate Solutions and Computershare. BGL managing director Ron Lesh said secure and convenient share registry data for SMSF administrators would save time and money. “Until now, BGL has only been able to supply our clients with bank account, contract note, ASX and Unlisted Unit Trust data,” Lesh said. “Registry data from Computershare completes the picture with fast and convenient access to payment information and shareholding balances.”