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Disclaimer

This is not advice. Items herein are general comments only and do not constitute or convey advice per se. The information contained in these articles is for guidance only and should not be relied upon without obtaining professional advice having regard to your direct circumstances.

 

Beat the cover charge

The strategy: To buy life insurance through my super fund.

Don’t I already do that? Most public super funds offer insurance – with some, it’s compulsory – but many investors still hold their life insurance outside super. Andrew Lawless, MLC’s head of technical services, says changes during the past couple of years to the super system have made it both attractive to hold both life and disability insurance through super.

The abolition of reasonable benefit limits means there is now no limit on how much insurance you can hold in super; those with terminal illnesses can now be paid their super (including insurance benefits) tax-free; and the treatment of total and permanent disability (TPD) and income protection insurance has become more tax-effective.

But why would I want to buy my insurance through my super fund? Lawless says life and TPD insurance premiums are normally not-tax deductible but if you buy your life insurance through your super, you can effectively pay with pre-tax dollars. If you are eligible to salary sacrifice or claim a deduction on your super contributions, the money contributed to pay for your insurance is before tax. Your super fund would normally pay 15 per cent tax on these contributions but because it can claim a tax deduction for the insurance premium, that offsets the contribution tax.

Lawless uses the example of Sarah, aged 40, who is self-employed and on the 41.5 per cent marginal tax rate. She needs $1 million of life cover, which costs $1379 in the first year. If she pays for the insurance outside super she will pay the full amount with after-tax dollars. But if Sarah made a concessional contribution of $1379 to super to cover the insurance cost, Lawless says she would be eligible for a tax deduction, reducing her tax bill by $572. The after-tax cost of the insurance would be reduced to $807.

Interestingly, Lawless found that if Sarah had already used up the $50,000 she is allowed in concessional super contributions, she’d still be better off contributing the extra money to fund her life insurance premiums. She would be hit with penalty tax of 31.5 per cent on the extra $1379 contributed but the after-tax cost of the insurance would still be $138 less than if she had bought it herself.

Don’t my beneficiaries get hit with tax if I hold my insurance inside super?  Death benefits paid to dependants – such as your spouse and minor children – can be paid out tax-free. If you want to leave the money to non-dependants, such as adult children, the payout will be taxed at 16.5 per cent or 31.5 per cent. (Lawless says the “future service portion” of your benefit – that is, the portion relating to the period between age 65 and when you die – will be regarded as an “untaxed component” of the death benefit and attract the higher 31.5 per cent tax rate). But he says it is generally cheaper to “gross up” or increase these taxes than to buy the insurance outside super from after tax dollars. To ensure the insurance is paid to the right person, you should lodge a binding nomination with your super fund and ensure it is updated as required.

So how does holding disability insurance through super help? Like life insurance, TPD insurance is not tax deductible if you buy it yourself, so it’s more tax effective to hold it through your super fund. No tax is payable on TPD benefits received from age 60 and while some tax will be payable before 60, Lawless says it’s again cheaper to simply gross up the insurance benefit to cover the tax than to buy the insurance outside super.

The thing to watch with TPD, Lawless warns, is the definition of disability. Some policies pay out if you are unable to work in your own profession, while others have a broader definition of disability and will pay out only if you are unable to work at all.

If you prefer the own occupation definition, holding TPD through your super fund may not be advisable. To pay the money directly to you, the trustee must confirm that you have meet a condition of release – such as reaching your preservation age (55) or becoming permanently incapacitated. If you are unable to work only in your profession, you may not satisfy the permanent incapacity test, which would mean your payout is locked in super until you reach retirement age.

Instead, Lawless says, you should buy a “connected” policy, where the life cover is provided through super and the TPD outside but you still get a discount for having both.

Income protection is tax deductible both inside and out super but holding it within super became more attractive last year, when the Tax Office announced it would allow a full deduction for premiums. Previously it only allowed deductions for two years’ worth of income payments.

Lawless says income protection benefits can be paid out of your super funds as an ongoing income stream and will be taxed as income in your hands – exactly as if you had bought the policy yourself.

By Annette Sampson, 24 September 2008
Money, Sydney Morning Herald

 


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