Insurance

Personal Insurances

The common belief that “it won’t happen to me” often results in many people having a sound plan for wealth creation, but not an adequate plan to protect the very thing that generates the wealth – themselves!

How death, disability or illness affects your ability (or your family’s ability) to realise your lifestyle goals and objectives will depend on the wealth protection strategy you have in place.

By taking out insurance you can provide some financial protection for your family’s personal needs. Insurance can be structured to provide for such things as the repayment of your debts upon death or disability, financial assistance for dependants, and protection against the loss of income.

Income Protection Insurance

Income protection insurance (also known as salary continuance) is designed to provide a regular income in the event that you are unable to work due to sickness or injury. Generally, income protection insurance provides a regular income during a period of disablement for up to a pre-determined and agreed benefit period. The benefit amount payable is up to 75% of your income.

Factors to be aware of:

• The shorter the waiting period and the longer the benefit payment period, the more the insurance will cost.
• Income protection insurance is important when borrowing to invest (gearing), as it can help meet interest payments if you are unable to work due to illness or injury.
• You should ensure your insurance cover is adequate for your needs. Under-insurance can present a serious problem.

Life Insurance

Life insurance can be critical for a secure financial future. In simple terms, you insure yourself for a particular amount, and in the unfortunate event that you die, the insurer pays that amount.

The lump sum payment can be used to help with the repayment of debts, the covering of future needs (for example, the cost of children’s education or long-term care), and providing funds for investment to generate an income, or to keep your business afloat.

Life insurance may be obtained via a superannuation fund.

Factors to be aware of:

• You should ensure your insurance cover is adequate for your needs. Under-insurance can present a serious problem.
• Changes in your personal circumstances (i.e. taking on additional debt) often necessitate higher insurance levels.
• Death benefits received via a superannuation policy may be taxed.

Total and Permanent Disability Insurance

Total and Permanent Disability (TPD) insurance will provide a lump sum payment should you suffer an illness or injury which totally and permanently prevents you from working again.

There are broadly two main definitions of Total and Permanent Disability:

• Own Occupation – The insured must show that they have a total and permanent disability that prevents them from working in their own occupation which they disclosed when applying for this cover.

“Own Occupation” is a more liberal definition of disability, because even if you can work in another occupation, you may still be eligible to receive disability benefits. Because it is relatively easy to qualify for benefits under this definition of disability, insurance companies are limiting the availability of this type of coverage. Own occupation coverage is often more expensive and may only be available to individuals who have a clean medical history and work in a relatively risk-free occupation.

• Any Occupation – The insured must show that they are totally and permanently disabled and unable to work in their usual, or any other occupation for which they are reasonably suited by their education, training or experience.

“Any Occupation” is often the cheaper option, however it can be more difficult to meet the requirements of this type of disability definition.
Some insurers have a third definition available to clients –a “homemaker” definition. Payment of benefits under this definition would be based on the proviso that the insured, through sickness or injury, is unable to do any normal physical domestic duties and will never be able to do so again.

Factors to be aware of:

• You should ensure your insurance cover is adequate for your needs. Under-insurance can present a serious problem.
• Changes in your personal circumstances (i.e., taking on additional debt) often necessitate higher insurance levels.
• There may be taxation consequences where a disability lump sum superannuation payout is made.

Critical Illness Insurance

Critical illness insurance (also known as trauma insurance) provides a lump sum benefit in the event that the life insured suffers a “critical condition” as defined by the insurance provider. Critical illness cover is designed to help you financially recover from a trauma or crisis, such as a heart attack, stroke, cancer or other life-threatening conditions.

Factors to be aware of:

• You should ensure your insurance cover is adequate for your needs. Under-insurance can present a serious problem.
• Critical illness cover is generally not held within super. However this insurance type may be connected with other insurances that are held in super, which can reduce the administration and costs of implementing the insurances via separate policies.

Insurances Inside Superannuation

It can also be beneficial to hold insurance via superannuation.

Insurance held via superannuation is owned by the Trustee of the super fund for the benefit of the insured member. The Trustee deducts the insurance premiums from either ongoing contributions or the account balance of the fund.

It is generally death, TPD and income protection that can be held in the super environment (not trauma cover). Also, the premiums for death, TPD and income protection insurances purchased through a superannuation fund are completely deductible to the fund. Furthermore, you can usually fund the insurance premiums via a tax-deductible superannuation contribution if you are self-employed, or out of your employer contributions made to your superannuation fund. Note that the tax treatment of an insurance policy should never be the primary reason for holding an insurance policy under a particular structure.

Insurance benefits can be paid out as either lump sums or pensions (or a combination of both) based on your (or your beneficiary’s) circumstances at the time. Insuring via superannuation can also assist with personal cash flow as the premiums are paid by the fund.

Preservation of Superannuation

Generally, money in a superannuation fund is ‘preserved’ until you attain preservation age and meet a condition of release (such as retiring from the workforce). Preservation age is currently between age 55 and 60, depending on your date of birth.

Conditions of release that may apply prior to preservation age include permanent incapacity, terminal illness and death. Other conditions of release that may apply prior to preservation age – including temporary incapacity, compassionate grounds, and severe financial hardship have “cashing restrictions” attached to them – which either limits the amount that can be paid to you or compels the fund to release benefits in the form of a pension rather than lump sum.

Death Benefits – Tax Dependent Beneficiaries

In the event of your death, the policy proceeds will be paid into your superannuation account. The proceeds together with your accumulated super balance will then be paid tax-free to your nominated beneficiary(ies) whether directly or via the estate.

Alternatively your beneficiary(ies) could choose to have some or all of your benefits paid as a tax-effective pension if that is their preference and they are eligible to do so at that time.

Death Benefits – Non-Dependent Beneficiaries

In the event of your death, the policy proceeds will be paid into your superannuation account. The proceeds together with your accumulated super balance will then be paid to your nominated beneficiary(ies) and/or your estate.

If your superannuation is paid to a non-dependent beneficiary(ies) on your death, it is anticipated that tax will apply. The amount of tax payable will depend on the components of the superannuation benefit, and whether the trustee has claimed the premium as a tax deduction.

When taking out insurance, there are generally two ways you can pay your premium.

• Stepped Premium – your premium increases every year with your age.
• Level Premium – your premium generally does not change and is based on your age when the policy commences.

While stepped premiums are usually lower in the early years, level premiums can be a more cost-effective option if you retain the insurance over a longer period. If insurance cover is only required for a short time frame, a stepped premium may be more appropriate and cost-effective.

Stepped vs Level Premiums

Level Premiums

Level premiums are higher than stepped premiums at the start (see graph below). However, as stepped premiums increase, level premiums can end up cheaper – often at the stage in life when you need the cover most. The premium savings in later years can make up for the additional payments in earlier years – saving you money over the life of the policy.

Combining stepped and level premiums

Just as you can opt for a combination of fixed and variable rate home loans, you may want to take out part of your insurance using stepped premiums and use level premiums for the rest. This way, the premium in the earlier years will be lower than if you opt entirely for level premiums.

Over time, you can then reduce your stepped premium cover as you build up more assets and potentially need less insurance. As a result, you could end up paying level premiums on most (if not all) of your insurance in the later years, and benefit from the lower premium costs associated with level premiums at that time.

Factors to be aware of:

• The earlier you ‘lock-in’ the level premium, the greater the potential long-term savings. This is because level premiums are generally lower if you take out the insurance at a younger age. However, as you approach age 65, the difference between the two premium structures diminishes for new policies.
• Level premiums can make budgeting easier, because you know in advance exactly what your insurance is going to cost.
• The maximum age you can start a policy with level premiums is generally lower than for stepped premiums.

Tax Deductibility of Insurance Premiums

The premiums payable on income protection policies are generally tax deductible; however, the income payments received will be taxed at the applicable tax rate.

Generally, death, trauma and TPD insurance premiums paid are not tax deductible, but when a claim is paid the benefits are not subject to tax.

Insuring via super can also be done within a Self-Managed Super Fund. The insurance held via a SMSF is not owned personally by you, but is owned by the Trustees of your super fund. You may fund the insurance premiums by contributing to super, or by paying the premiums from the balance of your SMSF. In most cases, insurance premiums paid by your SMSF may be claimed as a tax deduction by the fund.

Trustees of a SMSF must act in accordance with the fund’s Trust Deed. Some SMSF Trust Deeds may not allow insurances to be held, and so require amendments to implement the recommended insurance. It is also important to maintain Minutes detailing decisions made that affect the fund’s operations. Trust Deed amendments and the preparation of Minutes may include:

• ensuring the purpose of the insurance policies is documented,
• establishing a process for payments,
• ensuring the required payment options are allowed (such as a Pension), and
• binding nominations are made (where appropriate).

Critical Illness Insurance within a SMSF

Critical Illness insurance is generally not held within a SMSF as there is no specific condition of release for Critical Illness trigger events. Therefore when a benefit is paid to the fund you may not be able to access the proceeds of the payment.

If you do not meet a condition of release you may have to wait until you reach preservation age and retire (or meet another condition of release) to receive the benefit.

Only people that are in a financially comfortable position, and/or those who are close to reaching (or have reached) preservation age should consider this option.

There are also additional risks associated with holding Critical Illness within a SMSF if the purpose of the policy does not comply with the superannuation ‘sole purpose test’. This could lead to your SMSF becoming non-complying. However the superannuation regulatory authorities have indicated provision of Critical Illness benefits is permissible if you (in your role as Trustees) duly consider certain issues.

As Trustees you must determine whether the provision of Critical Illness insurance by your fund is acceptable, having regard to all the circumstances of the fund and rules of the fund (as set out in the trust deed).

Important matters to be considered and documented include but are not limited to:

• The design and purpose of the insurance
• The manner and time in which the trustee intends to distribute any proceeds of the policy
• The ratio of the premium to contributions being made
• Issues of ownership of the policy
• The superannuation benefit payment rules and
• Taxation issues.