Should I purchase life insurance in my super fund?

Many superannuation providers offer the option of purchasing life insurance through your superannuation fund. Self-Managed Superannuation Funds are also able to purchase life insurance within the fund. However, many people do not fully understand the advantages and disadvantages of purchasing life cover through their superannuation fund.

This article explains the implications of holding life insurance policies within superannuation funds, so that you can make an informed decision.

Advantages

Purchasing life insurance in your superannuation fund can be attractive. The life insurance premium, which can be paid from your member’s account in your superannuation fund, may not otherwise be accessible to you, if you are under preservation age (between 55 and 60 years, depending on your date of birth).

In most cases, the life insurance premiums are tax deductible within your superannuation fund. This means that the Government contributes 15% of the cost of your life insurance.

If the balance in your member’s account in your superannuation fund is paid as a lump sum to one of your qualifying dependants on your death, the life insurance proceeds will be paid to your dependant tax free, along with the balance of your superannuation fund.

For tax purposes, a death-benefit dependant is:

  • Your spouse or de facto spouse.
  • Your former spouse or de facto spouse.
  • You child who is under 18 years old.
  • A person who was financially dependent on you at your death.
  • A person who was in an interdependency relationship with you.

You may also choose to leave your dependant a pension from your superannuation fund, and the implications of this will be discussed in my next article.

Hence for many couples, holding life insurance policies within their superannuation is attractive, because they can use their superannuation monies to pay the life insurance premiums, claim a tax deduction for those premiums and the surviving spouse can extract the funds tax-free from the superannuation fund.

Disadvantages

Frequently, parents decide to leave the balance in their superannuation fund upon their death to their adult children. Adult children will only be dependants for tax purposes if they are financially dependent on the parent at the time of their death. Typical examples of a dependent adult child are where the child has a permanent disability or where the child lives with you and they are still in fulltime education.

If your child is not your dependant for tax purposes at the date of your death, tax implications arise when the lump sum death benefits from the proceeds of a life insurance are paid to them.

The tax implications are the same if you leave your superannuation fund to a non-dependent relative or friend.

Non-dependants are not able to receive a pension from your superannuation fund under the superannuation law.

The lump sum death benefits paid to a non-dependant from your superannuation fund will be split into three components:

  • The tax free component;
  • The taxed element; and
  • The untaxed element.

You may have a tax-free component in your superannuation fund if you have made after tax contributions to your superannuation fund.

Most people have a significant taxed element within their superannuation fund. The taxed element typically arises where you have made concessional (tax deductible) contributions to your superannuation fund or if employer superannuation contributions have been paid into your superannuation fund.

Some Commonwealth employees may have received untaxed elements into their superannuation fund.

Where your superannuation fund has claimed a tax deduction for your life insurance premiums, the life insurance proceeds paid to a non-dependant will be either fully or partially taxable. If you die before reaching retirement age, complex calculations will be required to decide how much of the life insurance proceeds are from:

  • The tax free component;
  • The taxed element; and
  • The untaxed element.

The tax-free component is determined based on the proportion of tax-free contributions in your member’s account in your superannuation fund. That is, if 10% of your member’s account is from after-tax superannuation contributions, 10% of the life insurance proceeds will be tax-free when paid to your adult child (or other non-dependent beneficiary).

 

 

Consequently, the remaining 90% of the fund must be split between the taxed and untaxed elements. The following formula is used to calculate the taxed element:

Taxed element = [Amount of super lump sum x service days/ (service days + days to retirement)] – the tax-free component

The untaxed element is calculated as the full amount of the member’s account less the tax-free and taxable components.

The untaxed element is taxed at the lower of 30% and the beneficiary’s marginal tax rate. The taxed element is taxed at the lower of 15% and the beneficiary’s marginal tax rate. In addition, Medicare levy and Medicare Levy surcharge may be payable on the lump sum payment, depending on the beneficiary’s income levels.

Therefore, if the life insurance proceeds are payable to a non-dependant such as an adult child, significant tax could be payable on the life insurance proceeds. In contrast, if the life insurance policy is owned by you personally, tax will not be payable on the life insurance proceeds paid to your adult child.

Conclusion

You should take appropriate advice before purchasing life insurance through your superannuation fund, particularly if your intention is for the life insurance proceeds to be paid to a non-dependant beneficiary such as your adult child.

Please contact me if you have any questions or require advice in respect of your superannuation circumstances.

 

 

Naomi Smith

Tax and Superannuation Specialist

Nexia Duesburys

12 May 2016

Phone: 02 6279 5400

Email: nsmith@nexiacanberra.com.au

 

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