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Self Managed Super Fund (SMSF) Article
Life insurance and SMSFs
By Tony Negline.
This article may be out of date.
7th September 2005
In early August the Investment & Financial Services Association released research which said that sixty percent of people with dependent children do not have enough life insurance cover to look after their loved ones for more than one year if they were to die.
It is easy to dismiss this research by saying either “well they would say that wouldn't they” or “it won't happen to me”. As the research shows, about 4,400 Australians with dependents die each year.
In October 2003, US based financial services Metlife released research that looked at families in which a spouse aged between 30 and 55 had died. Metlife found that 70% of widows and 53% of widowers believe the premature death of their spouse had a devastating or major financial impact. Half of the surviving spouses say that after 3 – 5 years their family's financial situation is still worse than prior to the death.
Superannuation is a great way to provide death insurance but it is not the only way and in many cases may not be the best way.
However for most people super provides a very effective and cost efficient way of buying life insurance. If you are going to use your super fund for your death insurance needs, there are two issues to consider.
The first issue is cost. Some people find financing death insurance costs difficult forgetting that these costs could be met by using employer Super Guarantee contributions or the Government's co-contribution scheme.
The next issue to consider is the taxation of an actual death benefit. It is commonly thought that the maximum super death benefit payable is up to a deceased's pension Reasonable Benefit Limit. That is, this year the flat dollar pension RBL is just under $1.3m (some older people have a Transitional RBL – TRBL – which will be higher than the flat dollar RBLs).
As usual this common perception is half right and half wrong.
Only certain Eligible Termination Payment components that are counted towards the pension RBL on death. This means Undeducted Contributions (which include the government's co-contribution) or Post June '94 Invalidity Component can be paid on top of amounts counted for RBL purposes. It is equally important to remember that any benefits which the deceased took prior to death that are counted against their RBL will also be taken into account when working out the amount of tax on any death benefit.
If a super fund member has not retired and the benefit is going to be paid as a lump sum then it will be assessed against the deceased's pension RBL.
Further if the people ultimately receiving this lump sum benefit are 'dependent' on the deceased then the death benefit up to the pension RBL are tax-free. A dependent includes a person's spouse, children under 18 and potentially others. If the death benefit is paid to a non-dependent then the flat tax-rate on the whole benefit under the pension RBL will be 16.5% on the Post June 1983 portion of the benefit (only 5% of the pre-July 1983 portion is tax at the recipients marginal tax rate).
However it might be profitable to pay a deceased pre-retiree member's dependent a pension. If the pension is paid to an adult dependent then it will be assessed against that adult's RBL to determine if the person is eligible for a 15% rebate on each pension payment. If an allocated pension is paid then it will be assessed against the adult dependent's lump sum RBL. This lump sum RBL will be reduced by 2.5% for each year the adult is aged under 55. Moreover this pension benefit will counted towards that person's RBL which might reduce their ability to plan their retirement.
If a new pension is paid to a child under 18 because of a pre-retirees death then that pension will not be counted for RBL purposes. These pensions will receive the 15% rebate. If there is a desire to pay an allocated pension and the child is very young then the level of income may be quite low. For example for children under 20 the income must be between 3.5% and 10% of the pension's account balance. If an allocated pension account balance is $250,000 then the income must be between $8,750 and $25,000. Assuming the child had no other income then very little income tax would be paid on these income amounts because of the 15% rebate.
Because of the above issues, many super members who haven't retired give their spouse a lump sum benefit and their young children a pension benefit.
If a death benefit pension is commuted to a lump sum and then rolled over to another pension after six months of death or three months of the granting of probate (whichever is the longer period of time) then the deceased's eligible service period will travel with the benefit. This can be very helpful if the eligible service period is before July 1983. In some cases young children can find their eligible start date is a date before they were born!
What happens if a super fund member dies when they have retired and are receiving a pension. Different rules apply which we will look at in another article.
This email is general in nature only and does not constitute or convey specific or professional advice. Legislation changes may occur quickly. Formal advice should be sought before acting in any of the areas discussed. Be aware that the information in these articles may become innaccurate with time. Responsibility is disclaimed for any inaccuracies, errors or omissions. Particular investments are neither invited nor recommended and hence this publication is not "financial product advice" as defined in Section 766B of the above legislation. All expressions of opinion by contributors are published on the basis that they are not to be regarded as expressing the official opinion of any other person or entity unless expressly stated. No responsibility for the accuracy of the opinions or information contained in the contributor's articles is accepted by any other person or entity. Copyright: This publication is copyright. If you wish to reproduce this article you require a license, which can be purchased here, to do so.