Self-managed super funds provide a significant opportunity when advising clients about their insurance needs.
Given the low level of insurance held by SMSFs (Cooper Review, 2010), legislation (SISR 1994 4.07D) was introduced requiring trustees to consider insurance needs for members.
Accordingly, advisers can help SMSF trustees assess insurance needs and satisfy their Trustee obligations.
Furthermore, there are unique opportunities to utilise tax concessions available to SMSFs.
What are the tax concessions?
While the focus should always be on the need for insurance, cover within an SMSF can provide tax concessions.
The SMSF can generally claim a tax deduction on the insurance premium for life insurance and any occupation TPD.
In addition, super contribution strategies (for example, salary sacrifice) can reduce the effective cost of cover by using pre-tax dollars.
Other strategies available include personal deductible contributions, co-contributions, spouse contribution tax offsets and contribution splitting.
How can proceeds be accessed?
Upon a successful claim, the insurance proceeds are received by the SMSF trustee.
A payment can only be made to a member or beneficiary if a condition of release and the terms of the governing rules are met.
Since 1 July 2014, the definitions of any new insurance policy must align with a condition of release.
This generally means no new ‘own occupation’ TPD or trauma through super, but existing member arrangements as at 30 June 2014 can continue.
The SMSF trustee is bound by the same conditions of release as all other fund trustees.
SMSF trustees must apply due diligence and ensure appropriate documentation is retained when releasing benefits.
If a condition of release is met and the governing rules allow, the benefit may be paid in the form of a lump sum or income stream.
A death benefit income stream can only be paid to eligible dependants and can be a tax effective option, allowing funds to remain within the SMSF environment.
What death benefit nominations are available?
Depending on the terms of the governing rules, SMSF members may need to rely on the trustee discretion in the event of their death.
Alternatively, if permitted by the governing rules, to ensure distribution of benefits according to a member’s wishes, a binding death benefit nomination could be established.
The Commissioner’s stated view (SMSFD 2008/3) is that a SMSF member can make a valid binding death benefit nomination if permitted by the fund’s trust deed.
The binding nomination can last indefinitely if the trust deed unambiguously permits and in this case, the nomination effectively becomes non- lapsing.
Any nominations should be reviewed regularly to ensure the desired estate planning outcome is achieved
Roger is the sole member of his SMSF and has two children, Lauren and Samantha. Lauren is a non-member trustee as Roger chose not to have a corporate trustee. Roger has not made any death benefit nomination. Lauren is also Roger’s legal personal representative. Roger dies and Lauren, as trustee, has full control over the SMSF and appoints her husband Ralph into the fund to satisfy the trustee requirements.
Lauren then distributes Roger’s death benefit to herself and denies any entitlements for Samantha.
If a dispute arises about an SMSF death benefit payment, the only option for potential beneficiaries is through the courts, which can be costly and protracted. There is no access to the Superannuation Complaints Tribunal for complaint resolution.
Roger could have avoided this unfair estate distribution if a valid binding death nomination was in force prior to death. In this case, Lauren must pay the benefit in accordance with Roger’s nomination provided the binding death benefit is valid.
What strategy is available upon benefit payout?
Where certain benefits (including death benefits, disability benefits and terminal illness benefits) are paid by an SMSF, a strategy whereby the SMSF can claim a tax deduction may apply.
If death or disability results in termination of employment, the SMSF can elect not to claim a tax deduction for the insurance premiums (in relation to the current and future income years) and instead claim a tax deduction for the future service element of the benefit payments.
The deduction is calculated as follows:
Total service days are generally the days from the service period start date to last retirement date (usually age 65)
This tax deduction may offset taxable income of the SMSF (such as taxable contributions and investment returns). Deductions that are not utilised in the year of the benefit payment may be carried forward as tax losses and utilised in later years.
Case study Henry, age 45, is employed and has an SMSF. He has $1 million life cover through his fund and an account balance of $250,000. His future service period is 20 years (to age 65) and the total service period is 30 years.
The annual premium cost is $1,750.
Henry dies and a total benefit of $1.25m is paid by the SMSF trustee to his spouse and children in combinations of lump sums and income streams.
Instead of the SMSF claiming a tax deduction for the $1,750 life insurance premium, an alternative tax deduction of $833,333 can be claimed in the year that the SMSF trustee pays the benefit payment based on the future service period. This amount is calculated as follows:
Tax deduction = death benefit x future service period /total service period
= $1.25m x 20/30*
This tax deduction may offset taxable income of the SMSF such that the SMSF may not pay tax in the current and future years (deductions that are not utilised in the year of the benefit payment may be carried forward as tax losses and utilised in later years).
*Years are used for simplicity. Actual calculation requires days.
If your client has an SMSF, a potential strategy is to include insurance within the fund. This approach may provide cash flow advantages and is a tax-effective method of holding insurance cover.
Binding nominations may also be considered to ensure benefits are paid to intended beneficiaries.
Advice is crucial to ensure the right outcome. The information in this article is of a general nature only, and does not constitute tax advice. We recommend you seek tax advice specific to your individual circumstances, from a tax adviser or registered tax agent.
Mark Gleeson is the technical services manager of ANZ Wealth
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