Insurance through super strategies

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1 Insurance through super strategies For advisers

2 Inside super or outside super? Insurance is quite often held within super because the premiums can be paid from accumulated super balances or employer contributions. This preserves an individual s disposable income. Alternatively, individuals can make additional contributions into super to fund insurance premiums by salary sacrificing through their employer, or if they are an eligible person* they can make tax deductible contributions into super. * An eligible person is a self-employed, substantially self-employed, retired or unemployed person. It also includes anyone who has less than 10% of total assessable income, reportable fringe benefits, and reportable employer super contributions derived from employment as an employee. Here is a quick summary of the differences between owning insurance inside and outside super: Issue Inside super Outside super Cashflow Tax on money to fund premium Access to insurance proceeds Tax on proceeds Premiums can be funded by super balance or contributions Generally no tax on contributions used to fund premiums Must meet a condition of release as well as the insurance definition. Problems may arise for younger individuals with TPD or trauma inside super Tax applicable if: life cover payment is made to a non tax-dependant TPD/trauma payment is made to an individual under age 60, or income protection payment (taxed at marginal tax rates) Premiums must be paid from disposable income After-tax money must be used to pay premium (up to 47.5% marginal tax rate applies) Insurance definition must be met to release proceeds Generally no tax on proceeds except income protection (taxed at marginal tax rate) Product features Restricted because of sole purpose test No restriction as sole purpose test does not apply outside super Product offering Timing of payment Beneficiaries Key considerations Trauma not generally offered in public offer funds Slower than insurance outside super as there is an additional release process from super Generally must be dependants as defined under super law All insurance products available Only one release process from the insurer Can generally be anyone There are some key considerations when holding insurance inside super: insurance proceeds must meet a super condition of release before they can be released (may get preserved inside super) tax on insurance proceeds may apply if insurance is held in super insurance products offered within super may have fewer ancillary features payment of insurance proceeds may take longer due to the additional process within super, and beneficiaries for life cover payments are generally restricted to dependants under super law. 1 Asteron Life

3 Tax concessions on super contributions to fund premiums Meet Grace 1 Grace earns $80,000 per annum. Her insurance premiums are $1,500 per annum for $1 million life cover. If Grace used her after-tax income, she would have to use $2,206 2 of gross income. However, if Grace chose to hold her life cover inside super, she would need to salary sacrifice only $1, Effectively no tax has been paid on this contribution compared to paying 32% marginal tax if insurance is held outside super. If an individual is an eligible person, they can claim a full deduction on contributions made into super. Therefore any contributions they make to super can fund premiums and also provide a tax deduction. Meet Robert Robert is a self-employed massage therapist. He earns $65,000 per annum. His insurance premium for $1.5 million life cover is $2,000 per annum. If he held this insurance outside super he would use $2,941 4 of gross income to pay the premium. However, if Robert chose to hold his life cover inside super, he would only need $2,000 of gross income. He could also claim a deduction of $2,000 on his contribution to super. Release and taxation of insurance proceeds from super A super condition of release must be met to release any super, whether the payment is funded by the accumulated balance or insurance proceeds. Life cover With life cover, there is usually no issue with releasing the proceeds from super, as death is a condition of release. Upon death, the balance of the client s account (including insurance proceeds) is generally paid to dependants (defined under super law) and/or the estate. The trustee of the super fund will only pay a non-dependant if they have exhausted all other avenues. If a super benefit is paid to a tax dependant, the entire benefit (including insurance proceeds) is tax-free if paid as a lump sum. A death benefit pension can only be paid to certain dependants i.e., spouse, certain children, interdependant or financial dependant. If paid to a child, they must be under age 18, aged between 18 and 25 and financially dependent, or disabled. If a death benefit pension is paid and either the deceased or the beneficiary were/are aged 60 or older, all payments will be tax-free. If both were/are under age 60, the taxable portion of pension payments will be assessable, but a 15% tax offset will apply. Something to note If the deceased was age 60 or older, the income payments from a continuing pension will continue tax-free to the reversionary dependant beneficiary. Payments to non-tax dependants can only be paid as a lump sum with the following tax rates applying: 1 This and the other case studies in this brochure are for illustrative purposes only and your clients' personal circumstances may be different. This example is based on Year 2 as the rebate only applies from Year 2. 2 $2,206 x 32% (includes Medicare levy and Flood levy) = $706. $2,206 $706 = $1, The contribution does not generally need to be grossed up for contributions tax as the super fund would normally pass on the deduction claimed on the payment of insurance premiums. Asteron Life 2

4 4 $2,941 x 32% (includes Medicare and flood levy = $941. $2,941 $941 = $2,000. Component Tax rate Tax-free 0% Taxable (taxed element) 15%* Taxable (untaxed element) 30%* * Plus Medicare levy An 'element untaxed' applies if the death benefit includes an insurance payment where either the premiums or future liability to pay a benefit have been claimed as a tax deduction by the super fund. This portion relates to the service period (i.e. generally the time period from the first date of contribution to the date of death) of the total benefit. Something to note If the proceeds from a life policy will be paid to a non-tax dependant, consideration should be given to holding insurance outside super so it can be received tax-free. Alternatively, the sum insured may be grossed up to allow for tax payable where insurance is held inside super. Meet Tom Tom (age 50) has a wife, Sandra (age 49) who does not work and an adult child, Sam (age 26). Tom passes away on 1 April His accumulated super totalled $100,000 and included a $42,200 tax-free component. He also had $400,000 life cover through his fund so the total death benefit is $500,000. His eligible service period started on 1 April Option 1 Sandra takes benefit as a lump sum (dependant) Sandra is a tax dependant so she can receive the $500,000 as a tax-free lump sum. Option 2 Sandra takes benefit as an income stream (dependant) Tom died before turning age 60, so the tax depends on Sandra s age. As she is under age 60, tax is payable at her marginal rate (less a 15% tax offset) on the taxable portion of income payments. Calculate tax-free/taxable split: Tax-free portion: $42,200/$500,000 = 8.44% Taxable portion: $457,800/$500,000 = 91.56% Sandra elects to draw a pension of $35,000. The taxable portion of $32,046 (91.56%) is included in her assessable income but receives a 15% tax offset. The remaining $2,954 is tax-free. Assuming Sandra has no other income or deductions: Gross pension $35,000 Less tax-free amount $2,954 Taxable income $32,046 Tax 5 $2,489 Medicare levy 6 $481 Less: 15% offset (15% x $32,046) $4,807 Tax payable $481 The 15% offset reduces Sandra s tax liability to $481, so she receives $34, $3,907 PAYG less $1,418 low income tax offset. 6 Medicare levy reduction has not been applied. 3 Asteron Life

5 Something to note Where death benefits (including insurance proceeds) are paid to dependants as a lump sum (including via the estate) no tax is payable. Tax may be payable if death benefits are taken as an income stream, although this can be reduced or eliminated through tax offsets. In addition, no tax is paid on earnings in the income stream. Option 3 Death benefit is paid to Sam (non-tax dependant) If Tom s benefit was paid to Sam (his adult child who is a non-tax dependant) it must be paid as a lump sum and tax is payable. Insurance is included in the benefit so an 'element untaxed' is calculated. Step 1 calculate the 'element taxed' This is a two-part process: (A) total benefit x service days 7 service days + days to retirement 8 (B) deduct the tax-free component from the amount calculated in (A) $500,000 x 8,401 = $302,630 13,880 element taxed = $302,630 $42,200 = $260,430 Step 2 remainder of the benefit is 'element untaxed' element untaxed = $500,000-$42,200-$260,430 = $197,370 Sam would pay tax of $105,143 on the $500,000 death benefit (see calculations in table below). 7 service days number of days from the start of the eligible service period to date of death. 8 days to retirement the number of days from death to last retirement day (usually age 65). Component Tax calculation Tax payable Tax-free component $42,200 x 0% nil Element taxed $260,430 x 16.5% $42,971 Element untaxed $197,370 x 31.5% $62,172 TPD cover TPD meets a condition of release if you also meet the definition of permanent incapacity 9 under superannuation legislation. In some situations flexible definitions such as Own Occupation TPD may not meet this requirement. If an individual applies for release of their TPD cover proceeds through the permanent incapacity condition of release, the super fund trustee must be reasonably satisfied that the individual is unlikely to engage in gainful employment for which they are qualified by training, education or experience. This criterion may be different from the insurer s criterion to pay insurance proceeds for TPD. The Any Occupation TPD definition, although it can still be different to the super release criteria, is closer than the Own Occupation TPD definition. Therefore, if an individual has a specialist occupation and requires Own Occupation TPD cover, holding insurance outside super may be a preferable option. Even if an individual has an Any Occupation TPD cover, there is still no guarantee that the insurance proceeds will be released from super. While TPD held inside super may not be suitable for younger people, it may be a viable option for those approaching preservation age (55-60 depending on date of birth). For example, if an individual, age 55, has TPD cover held inside super and the insurer releases the proceeds into their super account, they can apply for release of their super under the permanent retirement condition of release. 9 Or another condition of release. Asteron Life 4

6 In summary, if TPD cover is held inside super, the client must: 1. meet the TPD definition under the insurance contract (for the claim to be paid) and 2. meet the permanent incapacity definition or another condition of release under super law (to access the money). In addition, they may meet the disability super benefit definition under tax law so that an additional tax-free portion is calculated on a lump sum benefit. Something to note A disability super benefit will arise if the person suffers physical or mental ill-health and two legally qualified medical practitioners certify that it is unlikely the person will ever be employed in a job for which they are qualified (based on education, training and experience). TPD benefits can be received by the client as a lump sum or income stream. The following tax rules apply for disability payments from a superannuation fund: Client s age Lump sum Income stream payments Age 60+ Total benefit 0% Tax free Preservation age < age 60 Tax-free component 0% Taxed component first $165, % balance 15% Under preservation age Tax-free component 0% Taxed component 20% 11 Taxed portion of income stream is included in assessable income and taxed at marginal tax rates less a 15% tax offset. 10 Plus Medicare levy /12 threshold. Reviewed for indexation on 1 July each year. Where tax is payable on a disability lump sum, the sum insured may be grossed up to allow for this. Calculation of the disability super benefit The tax-free portion of a disability super benefit (lump sum) is calculated as: Additional tax-free = total benefit x days to retirement 12 service days + days to retirement This amount is added to the existing tax-free component in any accumulated savings. The above calculation applies to lump sums. If an individual who is under age 60 satisfies the disability super benefit definition and commences a pension, a 15% tax offset will apply. 12 Days to retirement = number of days from date of disability to date of retirement (usually at age 65). Meet John John is age 40 and has an accumulated super balance of $100,000 with an eligible service date of 28 November This includes a $25,000 tax-free component. He has $400,000 of life and TPD cover. On 12 July 2012, John becomes permanently disabled and requests to receive his benefit as a lump sum. The insurer pays the proceeds to the super fund trustee. The trustee agrees that the relevant definitions under super law (to access the benefit) and tax law (to qualify as a disability super benefit) have been met. 5 Asteron Life

7 The extra tax-free component is calculated as follows: Total benefit = $500,000 Days to retirement = 9,131 Service days + days to retirement = 16,662 $500,000 x (9,131/16,662) = $274,007 additional tax-free component Tax component Amount Tax Tax-free $299,007 nil Taxable $200,993 $200,993 x 21.5% (including Medicare) = $43,213 Total $500,000 $43,213 Income protection cover Income protection proceeds are generally released under the temporary incapacity condition of release that allows a non-commutable income stream to be paid to the individual. The total payment is taxable income and taxed at marginal tax rates regardless of the client s age. No special tax offsets apply. Release and taxation of insurance proceeds outside super The payment will be made to the individual or their beneficiary as long as the insurer s definition for release of insurance proceeds is met. There are generally no restrictions on who can be nominated as a beneficiary. Life cover and TPD proceeds from self-owned policies are generally received tax-free. Income protection proceeds are taxed at the individual s marginal tax rate. Product features The product features available on insurance products offered through super may be restricted/limited compared with those offered on insurance products outside super. This is because the super fund cannot offer an insurance product that would contravene the sole purpose test. Split TPD Split TPD works by splitting the Own Occupation TPD definition across two policies. The first policy contains the Life Cover and Any Occupation portion of the TPD definition this policy is held under super. Therefore, for this portion, a tax concession may be received on super contributions that fund premiums and any proceeds will be released and taxed according to super law (see 'Release and taxation of insurance proceeds from super - TPD cover'). The second policy contains the Own Occupation portion of the definition this policy is owned by a non-super entity such as the life insured. Therefore, this portion (if self-owned) will be received tax-free. There are no tax concessions available for premiums for non-super TPD policies. There may be intricacies at claim time as to which TPD definition will apply and when. For full details refer to the relevant PDS and Policy Document. Timing of payments When insurance is held through super, this creates an additional process before the individual or beneficiary receives the proceeds. The insurer first assesses whether the individual has met the relevant policy definition to pay a claim. If they have, the insurer will pay the benefit proceeds to the trustee of the super fund. The trustee must then consider whether a condition of release has been met before it can pay the proceeds, and any super benefit (if applicable) to the individual or beneficiary, whichever is applicable. In the event a death benefit is payable, the trustee may need to pay it according to a binding nomination. A valid binding nomination can speed up the process for the payment of life cover proceeds within the super fund. Asteron Life 6

8 Contact details Technical Services Suncorp Portfolio Services Limited ABN AFS Licence No For more information on Asteron Life product solutions, please contact the Sales Manager in your state. NSW & ACT Level Kent Street Sydney NSW 2000 T NSW callers outside Sydney: VIC/TAS Level 8 15 William Street Melbourne VIC 3000 T VIC callers outside Melbourne: QLD Kings Row Complex OCE Building Level 4 50 McDougall Street Milton QLD 4064 T QLD callers outside Brisbane: SA/NT Level Grenfell Street Adelaide SA 5000 T SA callers outside Adelaide: WA Level William Street Perth WA 6000 T WA callers outside Perth: Important note This material is current as at 5 March 2012 and may be subject to change. This information is provided for adviser use only and must not be given to any customer. Suncorp Life & Superannuation Limited ABN AFS Licence No Suncorp Portfolio Services Limited ABN AFS Licence No RSE Licence No L AS /02/12 A

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