The funding of life insurance within a super fund can provide various taxation concessions that are not usually available for life insurance policies held outside of superannuation.
Having sufficient insurance in the event of death is vitally important, especially for younger families with mortgages and young children to support.
An important consideration is whether to arrange the insurance inside or outside of superannuation.
Various tax concessions are available where insurance is arranged within superannuation. These include:
- The opportunity to reduce the net cost of insurance premiums. Premiums for life insurance held outside of superannuation are generally paid with after-tax dollars.Where insurance is arranged inside a superannuation fund, there is the opportunity to pay premiums from employer contributions that might be made from pre-tax income as part of a salary sacrifice arrangement. Cost savings on insurance premiums can also be used as an opportunity to increase the amount insured.
- Some premiums paid by the superannuation fund may be cheaper if the fund offers group rates, which is likely to be the case for employer funds.
- Insurance arranged within a superannuation fund can also reduce the superannuation fund’s taxable income. Employer contributions received by a fund are generally subject to contributions tax. Where life insurance premiums are funded from employer contributions (or salary sacrifice) the contribution is effectively not subject to tax. This is possible because the fund is entitled to a tax deduction for the insurance premium, which effectively offsets the assessable contribution.
- The fund can use the proceeds of the policy to commence tax effective superannuation pensions in favour of the client’s spouse and young children.The pensions paid to dependent children from life policy proceeds are partially tax free and partially taxed at marginal rates of tax (depending on the proportioning between taxed element of accumulations in the fund and the policy proceeds), or at 10% if the deceased was aged 60 or more at death. Note that, for taxation purposes, a child must be dependent upon the deceased if aged 18 years or more, and that dependency will be deemed to cease at 25 years of age, unless the child is totally and permanently dependent upon the deceased. Further, the pension death benefit paid to the child must be commuted by the 25th birthday of the child.If the children are under 18 then the trustee of the fund will pay the pension to the children’s parent/guardian to apply on behalf of the children.
A lump sum death benefit paid to a dependent is tax free. However, where a death benefit pension is paid to a dependent where both the dependent and the deceased was aged less than 60 at the time of death, the assessable income of the pension which relates to the insurance proceeds (referred to as the untaxed element in the fund) will be fully taxed. The balance of that income will be tax free. Where either the dependent or the deceased was aged 60 or more at the date of death (or reach that age where the death benefit was paid to them earlier), the untaxed element in the fund will still be taxed but with an offset so that it is taxed at rate of 10%.
Consider, Mike, aged 38.
Mike runs his own self-managed fund and his employer makes employer contributions to the fund.
His taxable income for the year is $250,000, ie. Mike is on the maximum marginal tax rate of 47%.
Mike has a superannuation balance of $300,000.
Outside of his superannuation fund, Mike has an ordinary life insurance policy, on his own life, to support Jane, his wife. The sum insured is $1,000,000. The annual premium is $2,500, which Mike pays from the joint bank account he holds with Jane (ie. paid from after-tax dollars)
Opportunities to take advantage of tax effective solutions
Instead of Mike paying for his life insurance from after-tax dollars, a tax effective solution would be to bring the policy within the self-managed fund, with the trustee of the fund owning the policy instead of himself. Mike and Jane also have two children and they would also like, upon their death, to have an ability to fund a small pension payment to each child until they are 18.
Mike arranges with his employer to salary sacrifice from his pre-tax salary an additional $2,500 to cover the life insurance premium.
In my calculations, the benefits of restructuring the life insurance in this manner are as follows:
- Mike’s annual insurance costs will effectively reduce by 47%. Instead of a post tax annual premium of $2,500, the same premium is now paid with pre-tax dollars that are salary sacrificed. A post-tax saving of $1,175 could be achieved.
- There will be no contributions tax payable on the employer contribution that funds the life insurance premium, as the fund is able to obtain a tax deduction for the insurance premium, which effectively offsets any contributions tax that would otherwise be payable.
- Any insurance benefit received if not used immediately to make loan repayments etc, may need to be invested to fund future lifestyle expenses and therefore is likely to be subject to tax. If Jane chose to take the benefit as a pension from the SMSF, there may be significant future tax savings.
Please contact me for help on whether to arrange your insurance inside or outside your super or with any other questions about either insurance or super. Email email@example.com or phone (07) 3007 2007.
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