Making the call on life insurance

If you're a trustee of a self-managed superannuation fund, the beginning of the new financial year is a trigger point to ensure your investment strategy is still on track.

Indeed, all SMSF members must specifically detail their chosen asset allocation strategy as part of the fund's annual return documentation.

But integral to the broader investment strategy process is another very important compliance obligation – and that is the consideration of risk protection.

It's a key to estate planning really, because while investing within the confines of superannuation always involves some degree of investment risk, overlaying this is the unseen risk of trustee mortality.

If you die unexpectedly, either before or after retirement, are your beneficiaries sufficiently protected?

Prior to legislation in August 2012, there was no legal requirement for life insurance to be considered for members of an SMSF.

Now, although death cover is not mandatory, all SMSF trustees are required to consider whether a fund should take out insurance for its members, and what level of cover that should be.

The SMSF insurance rules

Trustees need to document that they have considered what level of insurance cover is required for each member and, if required, whether the insurance is taken out inside or outside of the SMSF framework.

This can be either done as a trustees resolution', specifically relating to insurance, or it can form part of the fund's investment strategy. This means the resolution or paragraph must detail why insurance is either required or not required for members and, if needed, how much and where the cover will be taken out.

How much is enough?

The amount of insurance a person needs is based on two main components. The first amount should pay off any loans of the family of the deceased. The second is the lump sum required to increase the amount in superannuation so that an income can be paid to the dependents of the deceased.

As a general rule, the greater the value of loans that a person has, the higher the income they are earning, and the younger they are, the greater the amount of life insurance they need.

As a person gets older, and their investments including super increase in value, the less they need.

If it is deemed that some level of insurance cover is required, there are often very good reasons why the cover should not be taken within an SMSF.

One of the main reasons why people have an SMSF is to maximise the amount they have in superannuation. Because life insurance is an expense of a super fund, the premium costs reduce the earnings of a fund.

Getting life insurance quotes

Insurance is one area where an SMSF can be at a disadvantage when compared to large industry and commercial super funds. Because of their size these other funds have greater buying power that enables them to secure insurance cover for their members at very low rates.

Where the trustee/members of an SMSF want insurance, they should obtain quotes from several sources. These costs for their SMSF should be compared with the cost of insurance provided through managed super funds.

If the quote is competitive, then the cover can be arranged through the SMSF with it being shown as being the owner of the policy.

In this case, where insurance will be too costly inside the SMSF, the trustees can have their members sign a form stating they will not take out insurance within the SMSF.

One option can be for members to join an external fund that provides life insurance at a very reasonable cost and have some of their Superannuation Guarantee super contributions directed to this fund.

Whatever decision is made, the trustees of an SMSF will need to document the process and decision in some way. If trustees use a fund administrator for the SMSF, the life insurance requirement could lead to a small increase in their administration costs.

This is because service providers will need to include life insurance calculations and the extra documentation as part of their work. If trustees, however, do the calculations themselves and document the findings there should be no increase in administration fees.

Where life insurance is to be taken out through an SMSF, and there is life insurance in an existing super fund a member belongs to, the benefits in the other fund should not be rolled over until the life insurance has been taken out in the SMSF.

In the event of the member not being able to secure insurance cover, or the cost of the premiums will be too high, the insurance in the old fund should be left in place.

Is the risk worth it?

The consideration of insurance is an obligatory part of the SMSF compliance process. But just as important for trustees is the consideration of not having insurance cover.

Being without any level of insurance is an investment risk too big to take.