Many Australis donot pay attention to their insurance and hold the minimum super as provided by their employer sponsored funds. This can include automatic acceptance of options with no assessment of the personal situation of the individual and may or may not include life and TPD and income protection insurance. Many donot even know whether they have insurance and what their cover is! There are advantages to these ‘automatic’ insurances which provide a blanket cover for many – however, it may not be the right cover.
The major disadvantage is that the cover may not be appropriate for the personal circumstances of the individual. It is important when setting up an SMSF to obtain personal advice to determine the right insurance cover for yourself inside and outside your SMSF which may include insurance discussed below.
So what is SMSF Insurance and what do you need to consider?
There are 3 typical types of insurances can be managed within an SMSF:
- Life Insurance
- Total and Permanent Disability (TPD) Insurance
- Income Protection Insurance
We will now discuss the types of insurance, the benefits and disadvantages as well as structuring considerations inside and outside of SMSF.
What is Life Insurance?
Life insurance or Death cover is the most common and popular form of life insurance. Life insurance can help protect the financial future of your loved one if something was to happen to you. However, how much is enough and what is the right cover for me?
Life cover provides a lump sum in the event of the insured death or diagnosis of terminal illness, where death is likely to occur within 12 months.
A lump sum death cover payment can be used to provide a roof over your familieshead, finance your children’s education or provide an ongoing income for your loved ones. If you are diagnosed with a terminal illness you can make an advance claim on your death cover, to pay for medical costs and not financially burden your beloved family.
So how much is enough? Generally the death cover should cover any debt you have. If you have young children, you would like to consider their age in terms of schooling/ education up to the age of 18 and perhaps university.
If death was to occur, this may result in your spouse being unable to continue with their current occupation which will need to be considered in the correct cover to choose.
Naturally, insurance is not cheap, the older you are the more expensive insurance premiums are – after all insurance companies are not silly, as your risk of dying increases, so do your premiums, that is why is it is important to understand the difference between stepped and level premiums.
It’s beneficial to structure life insurance in your SMSF. Ensure the policy owner is the SMSF not in your personal name. Your SMSF may not be compliant if the policy is not structured correctly.
Note, life insurance premiums are not deductible in your personal name but are deductible in the SMSF.
The Importance of Life cover – a Case Study
Jack and Jill were married at the age of 30. They own a property in the suburbs of Melbourne recently valued at $900,000 with a mortgage of $600,000. At the time of purchase they obtained life insurance cover of $800,000. They have two young children, both attending private schools.
Unfortunately, 12 months ago, Jill was diagnosed with terminal cancer and was given 12 months to live. This illness met the insurer’s requirements and Jill made a claim on her life cover for the $800,000 and received a lump sum. This enabled Jack to pay off the debt on the home and assist with school fees and general living expenses. Having adequate life cover ensured that Jill’s loved ones did not experience undue financial hardship in the event of her premature debt.
What is TPD?
TPD is always provided along with life insurance, it provides a beneﬁt or “living insurance” in the event of becoming totally and permanently disabled or seriously ill at some stage of your life leaving you unable to work and provides a lump sum payment to replace your future earnings and cover medical costs. TPD insurance is quite controversial as each insure has a different definition or interpretation of what TPD is. It’s important to ask a lot of questions during the process and benefit from an experienced SMSF Advisor to ensure you know what you are paying your premiums for.
When considering TPD, once more you need to consider what the necessary cover will be within your cash flow expectations. Similar to Life, TPD should be held inside a SMSF rather than a personal name as the premiums may be cheaper and you may be automatically accepted.
The importance of TPD – A Case Study
Mark (48) and Beth(46) have two teenage children attending private catholic schools. Beth works full-time earning $100,000 per annum as a personal trainer and Mark $120,000 per year as an Accountant. The couple have a $400,000 mortgage on their principle place of residence, and they each acquired $800,000 of TPD insurance.
At the age of 46, Beth falls and breaks her neck. As a result, Beth is unable to work as a personal trainer. The injury meets the relevant insurer’s definition of TPD and pays her a tax-free lump sum of $800,000. This allows the family to pay off the mortgage and assist with private school fees as well as providing a regular income stream.
What is Income protection?
Income protection, often referred to as salary continuance, can help you manage your expenses if you are unable to work for a certain period of time – if you are sick or injured, income protection offers your members the assurance of a regular, ongoing income if they are unable to work due to illness or injury.It pays a monthly benefit of up to 75% of your regular before-tax income which can help you stay on top of your mortgage, rent and other expenses until you can return to work. This will include a waiting period of at least 30 days or 90 days, your choice will be impacted by your duration of employment (i.e. leavebenefits) as well as your current cash reserves. The benefits period can be two years or up to the age of 65.
In structuring income protection insurance, the premiums paid are generally deductible. It is more beneficial to structure income protection outside the SMSF as the individual’s tax rate is greater than that of the SMSF (maximum of 15%).
Income Protection – a Case Study
Jack took out income protection insurance in 2016 for 75% of his income up to the age of 65 with a 90 day waiting period. Jack broke his arm and was unable to perform his duties. Jack made a claim and this met the insurers’ criteria and was approved. Payments were immediately made to Jack.
What are the Advantages of having insurance owned by your SMSF?
- If the insurance premiums are paid from existing SMSF the members will have extra cash outside of super to pay for other living expenses.
- Super contributions are generally taxed at concessional rates, which can make members’ insurance premiums considerably cheaper than they would be on a policy outside of super. Therefore a greater tax deduction is possible.
- SMSFs may be able to claim deductions on TPD premiums which may not be available outside of super.
What are the potential Disadvantages of having insurance owned by your SMSF?
- Contributions made to the fund are used to pay the insurance premiums will reduce the investment balance – reducing your retirement nest egg
- Insurance premiums offered by retails or industry fund are group rates and are likely to be cheaper than the individual policies your SMSF can purchase.
It is important to consider your insurance prior to setting up your SMSF by obtaining financial advice to determine to adequate coverage for Life, TPD and Income Protection. After all, when you execute your investment strategy, Superannuation Law requires that you consider insurance coverage within the fund. Be sure the policy is in the SMSF name not your personal name for SMSF Compliance.
Ivan Filipovic is a leading SMSF Specialist Advisor with Redwood. Ivan has over 17 years provides a range of services across all sectors of Self-Managed Superannuation, Wealth, Property and Finance with an emphasis on long term wealth strategies. Ivan provides detailed strategies at https://redwoodadvisory.com.au/. Ivan is a Chartered Accountant, ASIC registered auditor, Mortgage Broker and Licensed Property Professional.