Holding insurance inside or outside super taxation issues

Transcription

1 Holding insurance inside or outside super taxation issues In this article, Midwinter s General Manager of Strategy and Technical Services, Matthew Esler, explores the tax opportunities that exist around holding term life, TPD, trauma and income protection insurance inside and outside super. Background It is important for risk specialists and financial planners to understand the tax implications of holding insurance inside or outside superannuation. This is especially true given the Government s announcement on 13 October 2009, that from 1 July 2011 premiums paid under the own occupation definition of TPD will not be deductible (or only partially deductible). The following provides a tax analysis of the types of insurance available inside and outside super - life, TPD, trauma, and income protection, and highlights opportunities within tax and superannuation legislation which will assist in providing optimal risk advice. Life insurance Life insurance is paid to the owner of the insurance policy in the event of death of the life insured (and in some cases where terminal illness has been diagnosed). Where the owner of life insurance is the individual, the proceeds are paid to the policy s nominated beneficiary or the life insured s estate (where no nomination exists). Where the owner of the life insurance is the superannuation fund, the proceeds will be paid at the trustee s discretion unless a binding nomination exists. The super fund trustee will pay the death benefits to either the life insured s dependants or their estate. Dependants includes a spouse, minor children, financial dependants or interdependent relationships (includes same sex de facto partners). Table 1 below highlights the tax implications of life insurance ownership. Table 1: Super v Life Insurance Taxation Premiums Deductible Not deductible Proceeds Not assessable to fund Not assessable* *The proceeds are not assessable to the individual and therefore no capital gains tax will be paid on the proceeds unless the beneficiary acquired their interest in the policy for consideration from the original beneficial owner. Where life insurance is funded through superannuation, Life insurance proceeds paid from a super fund will be tax-free if paid to death benefit dependants. If superannuation life insurance proceeds are paid to a non-dependent via the estate the lump sum is treated as assessable income any taxed element is taxed at 15% and any untaxed element is taxed at 30%. TPD Total and permanent disablement (TPD) insurance is paid to the owner of the insurance policy in the event of permanent incapacity. There are two main definitions of TPD insurance any occupation and own occupation. Whilst own occupation TPD is more expensive than any occupation TPD, it is more likely to be successful under a claim. However, if held within superannuation it may not be released, whereas any occupation is less likely to be successful under a claim but more likely to be paid out of a super fund. 1

2 Under the any occupation definition of TPD, a benefit is paid in the event that the life insured is unlikely to ever again be employed or self-employed for gain or reward in any business or employment for which they are reasonably qualified by education, training or experience due to physical or mental ill-health (refer to 6.01[2] SIS Regulations 1994). On the other hand, under the own occupation definition, a benefit is paid in the event the life insured is unlikely to ever again be gainfully employed in their own occupation. The decision to hold TPD insurance inside or outside superannuation has largely been dependant on what definition of TPD the life insured elected. This is because the own occupation definition of TPD is narrower than the definition of permanent incapacity under SIS (more akin to any occupation definition TPD). This meant that whilst own occupation TPD could be owned by the super fund, unless the life insured also satisfied the any occupation definition, the super fund would not be able to release the insurance proceeds to the life insured until another condition of release was satisfied (preservation age and no longer gainfully employed, age 65 etc). This decision to hold own occupation TPD outside superannuation has become easier still with the announcement by Chris Bowen, Minister for Financial Services, Superannuation and Corporate Law, on 13 October 2009, that from 1 July 2011, premiums funding own occupation TPD will not be deductible. From 1 July 2011, the law will revert to insurance premiums only being deductible to the extent the policies have the necessary connection to a liability of the fund to provide disability superannuation benefits to their members and not other types of insurance. Table 2 below highlights the tax implications of TPD insurance ownership: Table 2: Super v TPD Insurance Taxation Premiums Deductible only for Not deductible any occupation definition TPD from 1 July 2011# Proceeds Not assessable Generally not assessable^ #From 1 July 2011, premiums funding own occupation definition of TPD will not be deductible according to Media Release Transitional Relief For s: Deductibility of Disability Benefit Premiums, released 13 October Transitional relief applies from 1 July 2004 to 30 June 2011 for the deductibility of own occupation definition TPD. ^Depends on relationship of individual owner to life insured not assessable under section of ITAA 1997 where life insured is owner or relative of owner. Income Protection Income protection insurance (or temporary disability insurance) is paid to the owner of the policy as periodic payments over a benefit period (usually 2 years, 5 years or to age 65) following a waiting period (usually 30, 60, or 90 days). Where the owner is the individual or the super fund, income protection insurance is paid as assessable income to the life insured. On 28 th March 2007, the ATO released Tax Determination TD 2007/3 which allowed a deduction for income protection insurance benefit periods greater than 2 years but for a period not exceeding 2

3 the period of incapacity. Prior to this income protection insurance held within superannuation did not usually exceed 2 years. The following table highlights the tax implications of income protection insurance ownership: Table 3: Super v Income Protection Insurance Taxation Premiums Deductible Deductible Proceeds Not assessable (assessable to life insured) Assessable Trauma Trauma insurance is paid to the owner of the insurance policy in the event of the life insured suffering a traumatic event such as stroke, heart attack, or malignant cancer. Trauma insurance cannot be usually held through superannuation because it would contravene the sole purpose test. However, the ATO have released Draft Self Managed s Determination SMSFD 2009/D1 which, if finalised, would enable a SMSF to purchase trauma insurance and still satisfy the sole purpose test: provided any benefits payable under the policy: are required to be paid to a trustee of the SMSF; 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. The following table highlights the tax implications of trauma insurance ownership: Table 4: Super v Trauma Insurance Taxation Premiums N/A Not deductible Proceeds N/A Not assessable Enhancing insurance cover in super through optimal contribution strategy Many financial advisers do not implement optimise contributions to superannuation during the accumulation and transition to retirement phases. By implementing an optimised contribution and TTR strategy the ability of client to pay for insurance premiums is enhanced. Optimising Contributions (and premiums) - Accumulation Phase Many technical experts talk about salary sacrifice as an effective strategy during the accumulation phase. This is an ineffective top-down, accountancy-based approach to effective financial planning strategy. The best contribution strategy should be implemented bottom-up that is, utilising available net income in the most tax-efficient way to maximise net contribution to super (and therefore insurance premium). 3

4 Case study Obama & Michelle Obama and Michelle are married and are both aged 45. Let s assume Obama earns $80,000 p.a. in salary and Michelle earns $50,000 p.a. salary. Barrack has $80,000 in super and Michelle has $60,000. The couple have determined require a combined net income of $95,000 per annum. The following table highlights the difference in net superannuation contributions the couple can make salary sacrificing v optimising contributions to super. Table 5: Enhancing insurance premium through optimising contribution strategy Salary Sacrifice Strategy Optimised Contribution Strategy Gross Income $130,000 $130,000 Net Income $95,050 $95,050 Net Contribution 1 st year $8,500 $9,319 Total Balance Retirement $1,177,019 $1,192,626 Difference $15, % Financial advisers using standalone risk comparators should be aware that new software exists that enables seamless transition from needs analysis, to comparison, to recommendation, to statement of advice (SOA), combined with an ability to compare the tax impacts of ownership, as well as atclaim cash-flow analysis. Midwinter was ranked #1 risk comparator in Investment Trends 2009 Planner Technology Report For a free trial call

5 Contact Details Midwinter Financial Services Pty Ltd Level 11, 99 Elizabeth St Sydney NSW Toll free ACN To access your free trial of Midwinter s Reasonable Basis please click on this link Reasonable Basis Free Trial - and call for your access code. This is intended as general advice only and does not have regard to an investor s objectives, financial situation or needs. Before acting, investors should consider the advice in light of their own circumstances. Midwinter Financial Services Pty Ltd has endeavoured to ensure that the information contained in this communication is accurate, but to the maximum extent permitted by the Law, disclaims all liability for errors or omissions. All superannuation and taxation information is based on our understanding, and the continuation, of current taxation and superannuation legislation. The case studies included have been created to illustrate a specific concept only. 5