Taking out insurance

Everything an SMSF trustee should know about compliance.

Taking out insurance for members is another job that trustees of an SMSF must now be involved in. Prior to new legislation in August 2012 there was no legal requirement for insurance to be considered for members of an SMSF.

The regulation, however, only requires SMSF trustees to consider whether the fund should take out insurance for its members, rather than forcing them to take it out. This new requirement will add to the paper work required to be prepared by, or on behalf of, trustees of an SMSF.

Trustees will 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.

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

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. In the forms section of the survival centre is a worksheet that can be used to calculate how much insurance a member needs.

Even if as a result of doing the calculations some insurance should be taken out there are often very good reasons why this is not done 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.

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 through the large industry 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 the trustees, like industry and public offer funds, 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 industry fund that provides life insurance at a very reasonable cost and have some of their SGC 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. 

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