By Crissy DeManuele, Senior Manager - Product Technical, Life Insurance, BT.
Taking out insurance within super may be attractive to clients, particularly if this strategy can make premiums more affordable for clients.
However, whilst there are benefits to holding insurance within super, there are also things to keep in mind. Clients should be aware of the potential consequences and the added complexity that this strategy can create.
This article discusses both the advantages and disadvantages of holding insurance within super, and also discusses how clients can still have comprehensive cover and not be impacted by certain restrictions when insurance is held in super.
The advantages of holding insurance within super
- Ease of cash flow
One of the main reasons for holding insurance inside super is cash flow. When held in super, existing accumulated super benefits and employer super contributions can be used to pay for the cost of the insurance.
- Claiming a tax deduction for the cost of insurance
When insurance is held within super, clients can generally make tax deductible contributions into super to cover the premium costs, which can make it more tax effective to hold the cover in super.
- Automatic cover
Any employer super funds provide automatic group insurance cover which provides another benefit of holding insurance in super. In many cases, clients do not make an active choice to commence group cover. For example, default Term Life and Total and Permanent Disability (TPD) cover is usually provided on an opt-out basis. However, Income Protection (IP) cover, if offered, is more likely to be on an opt-in basis.
Often, group insurance is available through a MySuper account set up by an employer, and therefore insurance is funded through employer contributions into that fund. Hence, the insured person does not have to actively engage to obtain and maintain cover.
- Reduced underwriting
When group insurance is held within super, there is often no underwriting or reduced underwriting. Default cover is available to all people within a specific group, regardless of their health status. A personal statement is not required, and therefore loadings and personal exclusions do not apply (though blanket exclusions may). Therefore, clients who would otherwise be unable to obtain retail cover, or would have an exclusion or loading applied to their policy, may choose group insurance as an alternative. There may also be an automatic acceptance level that is higher than the default level of cover, and therefore a higher initial sum insured can be secured, without underwriting.
The disadvantages of holding insurance inside super
Holding insurance within super has its limitations.
- Group insurance may only provide a basic level of cover
As group insurance is only meant to offer a base level of cover, and because there are restrictions on what can be offered inside super, it may not be as comprehensive as retail insurance.
Retail insurance can be structured inside super, outside super, or a combination of the two. Group insurance inside super does not include Trauma, nor own occupation total and permanent disability (TPD) cover; furthermore, IP might not be as extensive as with a retail product.
There will generally be lower maximum sums insured and a lower number of ancillary benefits. TPD cover will usually be linked with Term Life cover, but will not have buy back options. The cover may also decrease as the insured person ages, which may not align with their needs.
Pre-existing condition exclusions may apply for one or two years, up to the lifetime of the policy. However, the insured person may be unaware of what these are. With retail cover, any pre-existing condition exclusions will be explicitly stated in the policy schedule.
- Restrictions on the types and features of insurance when held inside super
Not all types of life insurance can be held within super. Since 1 July 2014, the Superannuation Industry (supervision) (SIS) regulations have prohibited superannuation funds from providing insurance cover to a member unless the terms and conditions align with one of the SIS conditions of release. For this reason, Trauma cover and own occupation TPD cover cannot be purchased within super.
- Insurance benefits may become trapped within super
Prior to 1 July 2014, there were no such restrictions and all types of insurance could be held within super. If Trauma or own occupation TPD insurance were taken out within super prior to 1 July 2014, they can continue to be held within super. However, if the client makes a claim under these types of policies, the benefit may not necessarily be able to be released from super. In these situations, the benefit will become trapped inside super and the client will only be able to access the benefit once they meet a SIS condition of release, which may not occur until they retire or reach age 65.
- Potential tax payable on insurance benefits
There may be tax payable if an insurance benefit is paid out of super, which would not otherwise be payable if the insurance were held outside super. Income protection benefits must be included in the client’s assessable income whether the IP cover is held inside super or outside super.
However, death and TPD benefits paid are generally received tax-free when they are held for personal purposes and paid from a policy which is not held within super. If a death benefit is paid from super, and it is paid to a non-tax dependant such as an adult child, the recipient may pay tax of up to 32% on the benefit. If TPD benefits are paid out of super, tax of up to 22% may be payable on the benefit, depending on the age of the client.
- Holding income protection (IP) insurance in super
Where IP cover is held outside super, the premiums are generally tax deductible. If a client holds IP insurance cover inside super, the client can generally make tax deductible contributions and therefore achieve the same tax outcome. Regardless of whether IP cover is held inside or outside super, any benefits payable are generally taxable in the client’s hands. Therefore, IP cover is no more tax effective if it is held inside super.
For an IP benefit to be released from super, the insured person must meet the temporary incapacity condition of release. Under the temporary incapacity condition of release, a person must cease work due to disability to receive benefits from super. Therefore, if the client ceases work prior to disability, the temporary incapacity condition of release cannot be met and the IP benefit cannot be released from super.
Some IP policies have additional conditions which need to be met before a claim is payable, if the IP cover is wholly owned inside super and was taken out after 1 July 2014. This is due to the fact that super funds are prohibited from providing insurance cover to a member unless the insurance terms and conditions align with one of the super conditions of release.
Many insurers will only pay a claim if the insured person also meets a SIS condition of release for an IP benefit. For example, if the insured person ceases work prior to becoming disabled and the IP cover is held wholly inside super, a claim will not be payable, not even into the super fund.
Also, the temporary incapacity condition of release states that the benefit released from super cannot exceed the insured person’s pre-disability income. There are varying interpretations of what is meant by pre-disability income. Some insurers will only pay an amount to a super fund up to the client’s pre-disability earnings. Depending on the circumstances and the insurer’s definition of pre-disability income, this could result in a reduced monthly benefit being paid or no benefit at all being paid, even if the client has an agreed value IP policy. APRA will require that new IP policies from 1 October 2021 will generally be based on annual earnings at the time of claim, however not more than the previous 12 months of earnings.
Holding insurance in super with flexi-linking or super-linking
If clients still want to hold trauma insurance or own occupation TPD and pay for the premiums with some of their super, they can consider flexi-linking this type of cover with other cover, for example linking Term Life cover with TPD own occupation.
Flexible linking builds on the traditional concept of rider policies, but allows the rider to be held outside super. For example, an own occupation TPD or Trauma policy could be owned outside super, but linked to a Term Life policy which is held inside super. This is one of a number of ways flexible linked policies can be structured.
Super linking is another way that clients can hold policies outside super but pay for most of the premiums from their super account. Super linking is where a single policy is spread across the super and non-super environment. The portion of the policy that is held inside super is the part that would result in a claim that can be accessed under an SIS condition of release; the portion held outside super is that which cannot. For example, clients seeking to utilise their super to fund insurance premiums can access own occupation TPD use super linking.
The portion of the TPD policy that can be released from super (the any occupation portion) is owned inside super, and the own occupation portion is owned outside super.
The insured person will first be assessed against the any occupation TPD definition and any proceeds will be subject to potential superannuation lump sum tax on withdrawal. If they do not meet the any occupation TPD definition, only then will the insured person be assessed against the own occupation TPD definition.
With a super-linked policy, the portion of an IP policy that holds benefits releasable from super is owned inside super, with the remainder held outside super. Super-linking also allows for clients to receive their full agreed value monthly benefit even if the monthly benefit is higher than their pre-disability income. If a client ceases work prior to becoming disabled and they hold IP cover inside super which is linked to a policy outside super, the monthly benefit can be paid from the non-super policy.
If clients want to hold insurance within super they should be made aware of the limitations and potential consequences. They should consider holding insurance via flexi-linking or super linking so that they can hold the insurance in super but also link it to a policy outside super, which then allows them to have all types of cover and also have all the features which can be provided outside of super.
This article is for Financial Advisor use only.
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