Insurance

The goalposts on insurance keep moving, so members should stay on the ball when it comes to paying for it, in or outside super, to avoid incurring a tax penalty.

There has been a steady stream of government and Australian Taxation Office announcements on insurance, so DIY members need to be proactive in reviewing and updating their insurance strategies to adjust for changing rules.

Not an easy task

Deciding whether it is better to obtain essential insurance coverage inside or outside super is no easy task. Changes to the rules on income protection insurance perfectly illustrate the difficulties. Until 2007, super fund members could only claim tax deductions for income protection premiums when the policy provided benefits for up to two years.

Consequently, the preferred strategy was to obtain income protection coverage outside super to take advantage of full personal tax deductions for premiums on policies providing benefits for longer periods. The pre-2007 tax rules also limited the choices available to fund members with many funds offering inadequate income protection coverage, a drawback that still haunts certain industry funds today.

In 2007, when all income protection coverage attracted a tax deduction in super funds, many DIY members opted to take out new policies or transfer existing policies to their fund. This allowed the premiums to be funded with deductible super contributions or, where personal cash flow is limited, from existing super balances.

Unwelcome changes

The 2009 budget changes upset many super fund members who opted to move their income protection coverage to their super fund. The sharply lower concessional contribution cap of $25,000 ($50,000 for those over 50) has again removed or diminished the benefit of holding income protection inside super for fund members close to or already maximising their concessional contributions.

By buying income protection coverage separately in private names, these taxpayers can increase their tax deductions because of the full deductibility of income protection premiums.

Trauma insurance

Trauma insurance was the subject of industry discussion until the ATO clarified that holding trauma insurance inside super in itself would not contravene the superannuation law (in Self-Managed Super Fund Determination 2010/1). But a trauma policy providing for benefits to be paid to someone other than a trustee of the DIY fund would contravene the sole purpose test and not be permitted.

Holding trauma insurance in personal names outside super generally remains the most suitable option for members who anticipate requiring access to trauma benefits immediately. Unless the member is in a position to satisfy a condition of release such as retirement, most trauma events are distinct from the super permanent incapacity definition. So any insurance payout will be trapped in the fund until the member meets a condition of release.

Clearer TPD rules

The government has clarified the rules on total and permanent disability insurance. From July 1, 2011, TPD insurance premiums will only be deductible inside super to the extent that the policy provides benefits when circumstances meet the super “permanent incapacity” definition.

That is, a deduction is only allowed for the part of the premium that relates to providing benefits for “ill health where the member is unlikely to engage in gainful employment for which the member is reasonably qualified” - also known as “any occupation” insurance. If policies cover events such as loss of limbs, or pay out for an “own occupation” definition, the premiums will not be fully deductible.

Yet another development has surfaced in relation to the payout of life insurance proceeds inside super. Where a DIY fund has claimed tax deductions for life insurance premiums paid for a member, the insurance proceeds will create an untaxed element in any lump sum death benefit paid to non-taxation dependants. This is taxed at a higher rate than other benefit components in the hands of non-taxation dependants.

When a member dies in the accumulation phase, the ATO says life insurance proceeds should be added to the accumulation account. If the deceased member was in the pension phase, then the proceeds should be added to the pension account, without affecting its predetermined taxable proportions.

If the pension account was 100 per cent tax free (or had a high tax-free proportion), the insurance benefits would form part of the tax-free component that non-taxation dependants receive tax free.

This presents an opportunity for members with both accumulation and pension accounts in their fund. They should consider their situations carefully and potentially arrange for premiums to be paid from their pension account, particularly if it has a high tax-free percentage.

DIY members need to keep abreast of announcements in insurance and seek professional advice to make sure their strategies are up to date.

Keep score on deductions

Type of insurance	Premium tax deductible for individuals?	Premium tax deductible for DIY funds?
Life insurance	No	Yes
TPD	No	Yes – until July 1, 2011, after which an apportionment will be required
Trauma	No	No
Income protection	Yes	Yes
		Source: Dixon Advisory