Most people start their own self-managed super fund because they take an active interest in their investments and want to boost their retirement savings. Insurance is generally not on the radar.
But that is changing. Recent regulatory changes have made it compulsory for SMSFs to consider personal insurance for members of their fund as part of their overall investment strategy.
What’s more, this strategy must be reviewed regularly to ensure it reflects the changing circumstance of the fund and its members. Yet many fund members are still unaware that insurance can be held within their fund.
Most big super funds offer automatic life insurance cover. Chances are that when people roll money out of one of these funds into a SMSF they overlook the cover they are about to lose.
When you start your own fund you also need to take care of your own insurance. This need not be inside super, but there are tax and cash flow advantages for holding certain types of insurance inside your SMSF.
Types of cover
The new regulations don’t specify the type or amount of cover that should be considered, but the four main types of personal insurance you can hold in your fund are:
- Life insurance. This is designed to pay death benefits to your dependents or nominated beneficiaries when you die. To make sure benefits are distributed according to your wishes you might consider making a binding nomination. The payout can be in the form of a lump sum or income stream.
- Temporary or permanent disability (TPD) insurance. This covers the person insured if they suffer an illness or injury that prevents them from working. Policies that pay out if you are unable to work in your own occupation are more expensive than those that pay out if you are unable to work in any occupation you are qualified and fit to perform.
- Income protection insurance. This provides monthly income if you are unable to work due to sickness or injury. Traditionally, income protection insurance paid 75 per cent of salary for a two-year benefit period. Many funds now offer longer benefit periods up to age 65 with 85 per cent or more of salary.
- Trauma insurance pays out a lump sum if you are diagnosed with a life-threatening illness like cancer or a major heart condition. Trauma cover may be worth considering if you have low or no income protection. Because trauma benefits must be paid into the fund and released under strict guidelines, younger members may find the cash is trapped in their fund until they reach preservation age.
The rules governing SMSF insurance are set to change on July 1, 2014 when ‘own occupation’ TPD and trauma cover will no longer be allowed. But members who have existing cover inside their fund will be allowed to continue their policies.
Who does it suit?
The best a SMSF can offer if a member dies with no insurance is to pay accumulated benefits to financial dependents tax-free. Your individual circumstances will determine whether this is enough to offer peace of mind.
Just because SMSFs are now required to consider insurance doesn’t mean everyone will need it. You may already have sufficient cover outside super or in another super fund. Or if you are retired with no dependents, no mortgage and no debts then insurance is unnecessary.
But if you are still working, with children or other financial dependents, a mortgage and perhaps some geared investments, you need insurance. What’s more, you need sufficient cover to ensure that your family can maintain their current lifestyle if you were to die prematurely or suffer a serious illness or disability that prevents you from working for an extended period.
Even if you have a substantial amount in super, if you are under age 55 and unable to work due to illness or incapacity there are restrictions on how much money you can access under the financial hardship rules. Money will only be released after all other financial resources are exhausted.
The type of assets in your fund is also an issue.
It is becoming increasingly popular for SMSF to enter into limited recourse borrowing arrangements to buy property. Gearing into property is a long-term strategy but if your ability to repay the loan is disrupted then insurance is crucial to protect the fund’s cash flow and liquidity. This is especially so if property held by the fund had to be sold to pay a disability benefit to one member.
How does it work?
Insurance held inside super is owned by the SMSF trustee and not personally by members.
Insurance premiums can be paid from member contributions or out of existing member balances. This has the potential to aid members’ cash flow and deliver some valuable tax benefits.
What are the tax advantages?
Super contribution strategies such as salary sacrifice reduce the effective cost of insurance because they are paid out of pre-tax dollars. Similarly, self-employed members can claim a tax deduction for super contributions and effectively reduce the cost of premiums.
In addition, SMSF trustees can generally claim a tax deduction for premiums paid on life insurance and some types of TPD, but not trauma or income protection insurance.
The tax deductibility of TPD premiums depends on whether they cover your ability to perform your own occupation, which is partially deductible, or any occupation, which is fully deductible.
Structuring the right insurance strategy for your personal and family needs can be complex so you may need to seek professional advice.