Funding income protection and trauma insurance via superannuation

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1 TB 40 Funding income protection and trauma insurance via Issued on 16 June Summary The tax concessions available for certain contributions can make it tax effective to fund income protection (salary continuance) and trauma insurance via. However this should be just one of the factors to consider. There are potential consequences in the decision to fund income protection and trauma cover via. The considerations relate to accessibility of benefits and the taxation of any benefits paid from the fund. From 1 July 2014, a trustee is prohibited from providing members with insured benefits unless the insured event is consistent with the conditions of release for death, terminal medical condition, permanent incapacity or temporary incapacity. This means insured benefits must be able, in all circumstances, to be released to members. Consequently, from 1 July 2014, new trauma insurance will not be available in. Aligning the temporary incapacity condition of release to the insured benefits provided may alter the terms and conditions of new income protection policies available in after 1 The prohibition does not apply to the continued provision of insured benefits for members covered before 1 Income protection or trauma insurance acquired by a trustee before 1 July 2014 may continue after 1 July 2014 and the level of such existing cover may be increased or decreased. Tax concessions on contributions It is important to consider the tax concessions available to when determining whether or not to fund insurance via this structure. Employers making contributions on behalf of eligible employees (including salary sacrifice and guarantee contributions) as well as eligible individuals making personal contributions can claim 100% of these contributions as a tax deduction. Eligible individuals include those who receive less than 10% of their assessable income, reportable fringe benefits and reportable employer contributions from eligible employment. For more information on the tax deductibility of contributions, refer to Technical Bulletin 35. Whilst unlimited deductions can be claimed by the contributor(s), there is a limit on the amount of concessionally taxed contributions that can be made by or on behalf of an individual. This is referred to as the concessional contributions cap and contributions in excess of this cap are effectively taxed at the individual s marginal rate and an interest penalty applies. For more information, refer to Technical bulletin 59 Contributions. Other strategies available for contributions include: Employees and self employed people who may qualify for the Government co-contribution of up to $500 per annum. Contributions on behalf of a low income earning spouse may qualify the contributing spouse for a tax offset of up to $540 (18% of $3,000) per annum. Income protection via When funding income protection cover outside, premiums are generally tax deductible and policy proceeds assessable as income. Subject to satisfying any contractual requirements, in the event of a successful claim, policy proceeds are paid directly to the policy owner. It is useful, therefore, when considering funding income protection cover via, to compare the consequences of such ownership against self-ownership. Taxation of income protection premiums within When owned by a fund in respect of a member of the fund, the policy premiums are generally tax deductible to the super fund. Employer contributions and personal contributions for which a tax deduction has been claimed are included in the assessable income of the fund and generally taxed

2 at 15% (commonly referred to as contributions tax). Where a super fund pays a life insurance premium and claims a tax deduction for the premium paid, the tax on contributions may be removed or reduced depending on how the super fund accounts for the deduction. For more information refer to Technical Bulletin 27 Funding life insurance via. Income protection product offerings within from 1 July 2014 are likely to be inferior to those available before that date. Advisers should be aware of any changes in the terms and conditions of policies acquired from 1 July 2014 and consider whether the client may be better off funding income protection outside. Accessing income protection benefits within When received by a trustee, income protection proceeds can generally be released to the life insured (a member of the fund) under the temporary incapacity condition of release. A member is temporarily incapacitated where they cease work as a result of physical or mental ill-health which does not constitute permanent incapacity. Employment does not need to fully cease. If the temporary incapacity condition of release is met, income payments are paid from the fund to replace in part or in full, the gain or reward the member received before their incapacity. The payments cannot result in the individual s income exceeding their pre-disability income (eg they generally could not be simultaneously receiving full sick leave pay and benefits through this condition of release). Additionally, payments must not be paid from the member s minimum benefits. This essentially means the released funds must be sourced from an income protection policy. Changes to income protection insurance within from 1 July 2014 Income protection insurance within acquired from 1 July 2014 must generally be accessible to the member under the temporary incapacity condition of release. This will have the following impacts on new income protection policies within acquired from 1 July 2014: Grandfathered income protection insurance within acquired before 1 July 2014 Members who take out income protection insurance within before 1 July 2014 can continue that cover after 1 Those members can vary their level of cover from 1 July 2014, without affecting the ongoing exemption. For example, the cover could be increased or decreased, and associated premiums adjusted, after 1 The terms and conditions of income protection policies within offered before 1 July 2014 may be superior to those offered from 1 Taxation of income protection proceeds When the proceeds are paid to the super fund, the amount is not assessable to the fund. In the same way, when the benefit is paid to the member, the amount is not deductible to the fund. The benefits received from the fund are fully assessable in the hands of the member of the fund (even from age 60). The fund receiving and paying-on the proceeds of the policy may have a PAYG withholding obligation. Temporary incapacity condition of release It should be noted that the temporary incapacity condition of release (the most common condition of release used when paying out income protection benefits) has some limitations. New agreed value or guaranteed value contracts will not be available within as the amounts paid may exceed pre-disability earnings and may not be able to be released to the member. Offsets for employer paid leave entitlements or workers compensation the member is receiving will need to be built in to the insurance contract to ensure benefits do not exceed pre-disability earnings. Unemployed persons or persons on unpaid leave will not be eligible for income protection within super, as they cannot cease gainful employment (temporarily) and therefore will not satisfy the temporary incapacity condition of release. Total disability definitions, waiting periods and ancillary benefits may be impacted. Under the temporary incapacity condition of release, the combined total of the member s ongoing employment income and the amount able to be released from super is limited to the member s remuneration at the time they became ill. Sick leave is included in ongoing employment income. Indemnity or guaranteed? Under the temporary incapacity condition of release, the amount of the benefit is limited to no more than earnings in the period immediately prior to disability. Since a guaranteed benefit payment type is based on earnings just prior to the application for 2

3 cover, and indemnity is based on earnings just prior to claim, an indemnity option best corresponds to the requirements for a condition of release. the level of cover is increased or decreased and associated premiums adjusted, after 1 Problems with accessing the insurance proceeds may arise where the income protection policy has a guaranteed insured amount and the insured has had a substantial drop in income prior to becoming disabled. That said, the member may be able to access unreleased amounts at the time or at a later date under another condition of release (eg retirement or permanent incapacity). From 1 July 2014, new agreed value or guaranteed value contracts will not be available within. A trustee may apply, before 1 July 2014, to the regulator to grant approval for other exemptions. Tip: New trauma insurance via will not be available from 1 July 2014, so clients should establish cover beforehand if required. As the exemption requires the continued provision of benefits by the trustee to the member, a lapse in cover or rollover to another fund may result in losing the exemption. Trauma cover via It is possible to acquire trauma cover via before 1 Consideration needs to be given to such an arrangement by the fund trustee and the member to address potential hurdles such as the inability for the trustee to claim a tax deduction on the premium, the sole purpose test and access to benefits. No new trauma insurance via from 1 July 2014 From 1 July 2014, super fund trustees are restricted to offering insurance contracts where a condition of release is available upon successful claim. Insurance contracts may be entered into which provide cover for death, terminal medical condition, permanent incapacity and temporary incapacity. This change impacts all super fund offerings (including SMSFs), not just MySuper and forms part of the Stronger Super measures. Accordingly, new trauma insurance will not be available within from 1 The reason is, there is no condition of release consistent with trauma which would release the insured benefits, if there is a successful claim on the insurance contract. Grandfathered trauma insurance within acquired before 1 July 2014 The prohibition from 1 July 2014 will not apply to the continued provision of trauma insurance for members who took out cover before 1 That is, existing insurance arrangements in place before 1 July 2014 will not be affected. This exemption will apply even where: an insured event had not occurred before 1 Taxation of trauma premiums within Unlike death, TPD and income protection cover, trauma premiums are not tax deductible to a fund trustee. This means that where concessional contributions are made to fund trauma premiums, these contributions are taxed within the fund as there is no offsetting deduction for the premium. This has the effect of reducing the tax concession the individual receives on the premiums to the difference between the individual s marginal tax rate and the super fund tax rate of 15%. Even with this result, it can still be tax effective to fund trauma premiums via, given that such premiums are generally non tax deductible outside of the environment anyway. Example Veronica is a 45 year old, who is employed by her own company as a real-estate agent. Veronica will draw a salary of $200,000 this year. Superannuation contributions are made by her company to a selfmanaged fund. Veronica has death and TPD cover via her SMSF. Veronica requires $450,000 of trauma cover and is considering owning that cover either outside of or within her SMSF. A trauma policy with a $450,000 amount insured will cost $2,080 per annum. If the policy were owned outside of this amount would come from Veronica s after tax earnings. If the policy were owned by Veronica s SMSF her company could reduce her salary by the pre tax equivalent of this amount ($2,080 / = $3,887.85) and contribute this amount to. This would reduce Veronica s after tax income by $2,080 (the same as the cost of the trauma policy). This contributed amount would be taxable in her SMSF at a rate of 15% 3

4 ($3, x 15% = $583.17) leaving $3, in the fund before the payment of the trauma premium. From this amount the fund could pay the premium on the trauma policy of $2,080, leaving Veronica an extra $1, in the fund. Alternatively, Veronica s company could pay the fund just the trauma premium grossed up for contributions tax, ie an amount of $2, ($2,080 / 0.85 = $2,447.05), while the remaining $1, is paid to Veronica. After tax at a rate of 46.5% this leaves Veronica with an extra $ in her hand compared to her funding the trauma cover outside of. The sole purpose test The sole purpose test broadly limits the provision of benefits to a range of retirement or retirement related circumstances. The sole purpose test has been used by some commentators to suggest that trauma cover cannot be provided by a fund. The ATO has released a SMSF determination stating that a SMSF can own a trauma policy and not breach the sole purpose test provided any benefits under the policy: are required to be paid to a trustee of the SMSF; and are benefits that will become part of the assets of the SMSF at least until such time as the relevant member satisfies a condition of release; and the acquisition of the policy is not made to secure some other benefit for another person such as a member or member's relative. In addition, it states: In determining whether to offer trauma insurance, trustees should consider their obligations to members generally and factors such as the proportion of contributions applied to purchase insurance cover. An unreasonable diversion of contributions to premiums for the contingent trauma cover would be difficult to reconcile with the sole purpose test and the fundamental retirement objective of. Superannuation fund trustees should seek their own advice as to whether or not, in the circumstances unique to their own fund, the sole purpose test is satisfied where fund assets are used to pay trauma premiums. Accessing trauma benefits from To receive a benefit from a fund, a member must generally have satisfied a condition of release, including retirement after preservation age or attaining age 65. A person may also satisfy a condition of release where they have ceased gainful employment and are permanently incapacitated. A person is permanently incapacitated where a fund trustee is reasonably satisfied that the member is unlikely, because of physical or mental ill-health, to ever engage in gainful employment for which the member is reasonably qualified by education, training or experience. Where a trauma policy owned by a fund pays benefits upon the life insured suffering a trauma event, the policy proceeds would be payable to the fund. However the proceeds could not be paid to the member until they satisfied a condition of release, which may be retirement after reaching their preservation age. Suffering a trauma condition is not necessarily a condition of release. It may be more appropriate for clients who have not already satisfied a condition of release (or are not close to satisfying a condition of release) to fund trauma cover outside. This approach ensures immediate access to benefits following a successful claim. Taxation of trauma proceeds Trauma proceeds paid to a fund are not generally subject to tax in the fund. Trauma benefits received from a fund are taxable according to their components, the age of the recipient, the form of benefit (eg lump sum or pension) and the event resulting in the payment (eg permanent incapacity, death or terminal illness). Where trauma benefits are added to a fund member s account, they are generally allocated to the taxable component. A member who is permanently incapacitated may be eligible for an additional tax free component on payment of a disability lump sum. Suffering a trauma condition, however, will not necessarily create a tax free component. This position should be compared to the taxation of trauma policy proceeds on a policy owned outside of the environment. Non trauma proceeds are generally This Technical Bulletin has been produced by OnePath Technical Services and is intended for the use of financial advisers only. It is current as at the date of publication but may be subject to change. This publication has been prepared without taking into account a potential investor's objectives, financial situation or needs. Before making a recommendation based on this publication, consider its appropriateness based on the client s objectives, financial situation and needs. OnePath Technical Services is not a registered tax agent under the Tax Agent Services Act Your client should refer to a registered tax agent before relying on information in this publication that may impact their tax obligations, liabilities or entitlements. 4

5 received tax-free where paid to the life insured or a relative of the life insured. This Technical Bulletin has been produced by OnePath Technical Services and is intended for the use of financial advisers only. It is current as at the date of publication but may be subject to change. This publication has been prepared without taking into account a potential investor's objectives, financial situation or needs. Before making a recommendation based on this publication, consider its appropriateness based on the client s objectives, financial situation and needs. OnePath Technical Services is not a registered tax agent under the Tax Agent Services Act Your client should refer to a registered tax agent before relying on information in this publication that may impact their tax obligations, liabilities or entitlements. 5

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