Sep 1, 2021 | Superannuation advice

Life Insurance and Super: To claim or not to claim?

Life Insurance Premiums – What you need to consider so you are not paying unnecessary tax!

Typically, once a member makes the decision that they need life insurance coverage the next point on their mind is usually whether to hold a policy inside or outside of superannuation.  

Most members would automatically jump to the conclusion it’s better to hold their life insurance inside their SMSF as the premiums are not tax deductible to the individual and therefore need to be funded by after-tax dollars. 

Alternatively, if a member holds a life insurance policy inside their SMSF, they don’t have to fund the premiums out of their own pocket and the fund is able to claim these premiums as a tax deduction against the assessable income of the fund. Whilst claiming the tax deduction is an obvious advantage there are also disadvantages of paying premiums from super which include the erosion of a member’s super balance – especially as premiums tend to increase as the member gets older.  

Whilst these points are valid there are a couple of other issues often overlooked by trustees and their accountants in relation to life insurance premiums which we’ll discuss.

Should I claim a tax deduction for the premiums?

It’s important to note that when life insurance proceeds are received by the fund from the insurer this amount is not taxable to the fund.  However, it is necessary to consider who the end beneficiary of the insurance policy is as there may well be tax consequences for the beneficiary when the proceeds are paid out. 

Just because premiums are tax deductible in a super fund doesn’t necessarily mean that they should be claimed. 

If insurance proceeds are paid as a lump sum to a “tax dependant” such as a spouse, a child under the age of 18 or someone the deceased held an interdependency relationship, then the whole amount of the death benefit payment including the life insurance will be tax free.  However, where the beneficiary of the death benefit is to a non-dependant the tax consequences can be quite significant. 

Insurance proceeds when paid into an accumulation account form part of the taxable component of the fund.  If the premiums have been claimed by the fund, then it is necessary to calculate an “untaxed element” but this applies to not just the insurance proceeds, but is calculated on the total value of the taxable component in the members account. 

It is, therefore, very important to consider who the end recipient of any insurance proceeds will be before deciding to claim a deduction.

Where do I pay my insurance premiums from?

The introduction of the Transfer Balance Cap also means careful consideration needs to be given to where the premiums are paid if a member has both a pension and an accumulation account. 

It is not surprising that this is often ignored and that most people would think it is better to be paid from the accumulation account to maximise both the ECPI and the amount retained in a tax-exempt environment. 

It is important to note that when insurance proceeds are received, they are allocated to the account where they have been paid.  If the beneficiary is a dependant with a reversionary nomination in place, paying the premiums from a pension account instead of the accumulation account could potentially be a better option as the insurance proceeds won’t be considered when assessing the Transfer Balance Cap.  The reason being when a reversionary nomination is in place the balance in the account on the date of death is what is assessed toward the beneficiaries’ cap but not assessed to them until 12 months later.  As the life insurance proceeds are not normally received by the fund until after the date of death the beneficiary is able to retain the full amount in pension mode as it isn’t caught in the cap assessment. 

However, if the premiums are being paid out of the accumulation account or from a non-reversionary pension account then there may be an impact on the Transfer Balance Cap and the excess may need to be withdrawn from the fund into a less tax effective environment. 

Summary

As highlighted not only is holding life insurance in the superannuation environment an important decision but where to pay the premiums from, should the premiums be claimed as a tax deduction and who is the end beneficiary are also vital considerations many people don’t think about. 

Whether to nominate a reversionary pensioner can also have a major impact on the fund as well. 

Failing to consider these factors may result in more tax being paid by the beneficiary then is necessary.

For further information on this article please contact Karen Dezdjek or Olivia Long of our office.

The information in this article contains general advice and is provided by Primestock Securities Ltd AFSL 239180. That advice has been prepared without taking your personal objectives, financial situation or needs into account. Before acting on this general advice, you should consider the appropriateness of it having regard to your personal objectives, financial situation and needs. You should obtain and read the Product Disclosure Statement (PDS) before making any decision to acquire any financial product referred to in this article. Please refer to the FSG (primefinancial.com.au/fsg) for contact information and information about remuneration and associations with product issuers. This information should not be relied upon as a substitute for professional advice, and we encourage you to seek specific advice from your professional adviser before making a decision on the matters discussed in this article. Information in this article is current at the date of this article, and we have no obligation to update or revise it as a result of any change in events, circumstances or conditions upon which it is based.

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