Insurance through your SMSF
They say that the best insurance is the one that you never make a claim on, and it seems that many self-managed superannuation fund (SMSF) trustees had in the recent past mistakenly taken this to mean that not having any insurance cover at all was a viable option (a relatively recent review of the sector found that only 13% of funds were covered).
But the regulator disagreed — especially in the face of the statistical data available on the realities of injury, illness or death throughout the nation’s working population.
Therefore, since mid-2014, the regulations that govern SMSFs stipulate that trustees are required to consider the insurance needs of every fund member and, to remain compliant, document that this has been done as part of the fund’s investment strategy. Advisers to SMSF trustees are also required, through reforms to the Future of Financial Advice (FOFA) regime, to advise their SMSF clients of the need to consider insurance under the umbrella of their “best interest” duty.
So with insurance needs firmly on the agenda (although note that actual cover is not required, merely evidence that it has been considered), SMSF trustees need to ensure their fund meets these requirements. Using a checklist of issues to consider is one way to achieve this, as is having each member of the fund sign a declaration that they have considered their insurance needs.
An example of issues to consider in a checklist include:
- Do you have existing insurance (either outside or inside superannuation)?
- How much insurance does each member need? (Each member’s needs will be different depending on their age, financial situation, type of employment and will change over time.) Consider the following:
- amount needed to extinguish debt – the more debt the more insurance you are likely to need
- ongoing family costs such as schooling, day care, etc
- income for spouse of deceased to maintain living standards
- legal costs
- time period until retirement age reached – the longer until you reach retirement the more insurance you will need
- nature of work – some occupations are inherently more dangerous and thus more likely to see a claim
- Have you considered the tax effectiveness of insurance in superannuation?
- Have you considered the pros and cons of insurance in your SMSF?
Advantages and disadvantages
In determining whether to have insurance within their fund, trustees need to consider the advantages and disadvantages of having their insurance in their SMSF.
Advantages of having Insurance in an SMSF
Some of the advantages of having insurance in your SMSF include:
- While life insurance is not deductible in the hands of an individual, it is deductible in the hands of the SMSF. This may make it more attractive to hold the insurance in superannuation.
- It is an effective means of ensuring protection. While we all like to think we will live long healthy lives, the reality is some of us will get injured at work, die suddenly or get a permanent injury. Insurance is an effective means of protecting yourself and your loved ones against such occurrences.
- Using your superannuation contributions to pay for insurance is a way of having insurance without it affecting on your cash flow. People may find they do not have the additional funds to pay for insurance, so using contributions or funds within the SMSF are one way around this.
Disadvantages of holding insurance in an SMSF
While reviews of the sector have recommended that funds have insurance, and all MySuper funds will have minimum insurance requirements, there are disadvantages, particularly for SMSFs, of holding insurance in the fund. These disadvantages include:
- Difficulty transferring personal insurance into your superannuation fund as insurance has to be in the name of the fund not the individual. Transferring insurance to your SMSF may mean cancelling one cover and starting new cover, in which wait times and exclusions may apply.
- Premium costs of insurance in SMSFs compared to group cover. Many group superannuation funds have coverage in bulk at discounted rates. It may be cheaper to retain some amounts in an existing group superannuation fund to retain access to insurance benefits. This is particularly important where you have an existing health condition and transferring to an SMSF may result in exclusion or premium increases.
- The drain on assets, as the cost of insurance may come out of either your contributions (limiting the growth of your fund assets) or reducing your investment balance. Either may be costly in the long run for the fund.
- Tax payable in superannuation. Life and total and permanent disablement (TPD) insurance payouts may be taxable in the fund. A life insurance payout to a non-dependent child will be subject to taxes up to a rate of 31.5%. TPD insurance payouts in a super fund will be subject to tax under lump sum payment rules. A tax rate of 21.5% may be applied to a portion of the payout.
- Payments from insurance may be trapped in the fund. Some “own occupation” TPD payments may not give rise to a condition of release, trapping the insurance payout in the fund.
Trustees therefore need to adequately consider the advantages and disadvantages of holding insurance in their SMSF. They must also consider whether it is better to hold any insurance in their fund or maintain it outside the superannuation fund, as well as the costs of having insurance.
The requirement that trustees evidence consideration of insurance, while not requiring actual cover, is in itself indicative that the regulator recognises that insurance held within an SMSF may not suit every circumstance. While the small percentage of SMSFs with insurance protection may be a reflection of a lack of consideration of insurance needs or a lack of understanding of insurance, it may also be as a result of a rational weighing up of the pros and cons and a considered determination that there are better avenues for holding insurance than through their SMSF.