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Self Managed Super Fund (SMSF) Article
SMSFs and life insurance

By Tony Negline.

This article may be out of date.

1st December 2004

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Winston Churchill once famously remarked: “If I had my way, I would write “insure” over the door of every cottage and upon the blotting book of every public man because I am convinced that for sacrifices which are inconceivably small, families can be secured against catastrophes which otherwise would smash them up forever.  It is our duty to arrest the ghastly waste not merely of human happiness, but of national health and strength which follows when, through the death of the breadwinner, the frail boat in which the fortunes of the family are embarked founders, and the women and children are left to struggle helplessly on the dark waters of a friendless world.”

Recent market research conducted by CommInsure, Commonwealth Bank’s life insurance subsidiary, reveals that some Australians don’t share Churchill’s view.  According to the research, twenty six percent of Australians who have no life insurance think it is a waste of money. 

Eighty percent of people who have life insurance think they have the right amount of insurance.  However CommInsure claims that their research shows that most Australians do not have adequate life insurance.  They would say that wouldn’t they?

Life insurance is a much broader product category than death cover.  Life insurance companies are allowed to cover a range of circumstances such as income insurance to cater for temporary incapacity caused by sickness or accident, permanent disability and even trauma insurance which covers a range of severe medical illnesses.

Interestingly Churchill seems to imply that it isn’t necessary to have any life insurance for a family’s low income earner.  This can be a big mistake.  If a spouse who stays at home to care for the family died or was severely disabled, how would the main income earner work and care for the family at the same time?  There will be very few cases when some form of insurance is not essential for an adult.

A key planning issue for anyone taking out life insurance needs to decide what entity will own the insurance policy.

Superannuation is often a good place to hold these insurances.  The super fund itself might be able to pick up some tax concessions which may not be available if the insurance policies are held personally.  Additionally any benefit paid from a super fund because the death or disablement benefit might also be concessionally taxed when paid to the super fund member.  It is no wonder that many use super funds to hold their life insurance policies.

However any super fund trustee needs to be very careful to ensure that the insurance policy they buy pays out on exactly the same conditions as the fund’s trust deed and the super laws.

For example suppose a super fund decides that it is a good idea to purchase a life insurance policy which insures a fund member for death, permanent disablement and trauma.  The member is under the impression that if they became terminally ill or suffered a listed medical illness, they would receive a benefit from the fund because of this trauma insurance.

If a trustee received the proceeds of a trauma insurance policy they may be tempted to automatically pay that money to the member.  However if they did this they may be breaking some important regulations.

Any proceeds that a super fund receives from a life insurance claim will be a preserved benefit and cannot be paid until a member satisfies a Condition of Release.

There are ten Conditions of Release – death, permanent incapacity, temporary visa holders permanently leaving Australia, severe financial hardship, being 65 years of age, compassionate grounds, leaving an employer, temporary incapacity or any other condition approved, in writing, by the regulator.  Some of these rules have restrictions on how much money can be withdrawn from super especially before retirement.

If a super fund owns a trauma policy and the super fund successfully claims on that policy because a member is terminally ill or suffers from a listed medical illness, will be member automatically receive the policy proceeds?

We cannot sure that the member will receive any benefit from the insurance policy.  What Condition of Release has been satisfied?  A trauma benefit might be payable to the member before retirement under permanent incapacity, severe financial hardship, compassionate grounds or temporary incapacity.  But have all the rules which govern any of these types of benefits been fully satisfied?  Some people assume that getting a medical trauma will always mean you will be permanently incapacitated.  But this is not necessarily the case.  Medical traumas are emotionally draining but don’t automatically mean that a person will never return to work.

The super fund can claim death, income protection (for up to two years income payments) and permanent disability insurance premiums as a deduction.  Trauma insurance is not allowed as a tax deduction.

Why would a super fund consider owning a trauma policy if the benefit can’t be paid?  One possible reason might be to ensure that a member’s retirement funding continues.  Suffering a medical trauma might involve a period of time off work which might mean a loss of income which means that super contributions may not be possible.

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