Insurance through your SMSF
They say the best insurance is the one you never make a claim on. It seems many self-managed superannuation fund (SMSF) trustees had in the recent past mistakenly taken this to mean that not having any insurance cover at all was a viable option (a relatively recent review of the sector found that only 13% of funds were covered).
But the regulator disagreed — especially in the face of the statistical data available on the realities of injury, illness or death throughout the nation’s working population.
Since mid-2014, the regulations that govern SMSFs stipulate that trustees are required to consider the insurance needs of every fund member and, to document that it’s been done as part of the fund’s investment strategy.
Advisers to SMSF trustees are also required to advise their SMSF clients of the need to consider insurance under the umbrella of their “best interest” duty.
So with insurance needs firmly on the agenda (although note that actual cover is not required, merely evidence that it has been considered), SMSF trustees need to ensure their fund meets these requirements.
Using a checklist of issues to consider is one way to achieve this, as is having each member of the fund sign a declaration that they have considered their insurance needs.
An example of issues to consider in a checklist include:
- Do you have existing insurance (either outside or inside superannuation)?
- How much insurance does each member need? (Each member’s needs will be different depending on their age, financial situation, type of employment and will change over time.) Consider the following:
- amount need to extinguish debit - the more debt the more insurance you are likely to need.
- ongoing family costs such as schooling, day care, etc.
- income for spouse of deceased to maintain living standards.
- legal costs.
- time period until retirement age reached – the longer until you reach retirement the more insurance you will need.
- nature of work – some occupations are inherently more dangerous and thus more likely to see a claim.
- Have you considered the tax effectiveness of insurance in superannuation?
- Have you considered the pros and cons of insurance in your SMSF?
Advantages and disadvantages
In determining whether to have insurance within their fund, trustees need to consider the advantages and disadvantages of having their insurance in their SMSF.
Some of the advantages of having insurance in your SMSF include:
- While life insurance is not deductible in the hands of an individual, it is deductible in the hands of the SMSF. This may make it more attractive to hold the insurance in superannuation.
- It is an effective means of ensuring protection.
- Using your superannuation contributions to pay for insurance is a way of having insurance without it affecting on your cash flow.
- Difficulty transferring personal insurance into your superannuation fund as insurance has to be in the name of the fund not the individual.
- Premium costs of insurance in SMSFs compared to group cover.
- The drain on assets, as the cost of insurance may come out of either your contributions (limiting the growth of your fund assets) or reducing your investment balance.Either may be costly in the long run for the fund.
- Tax payable in superannuation. Life and total and permanent disablement (TPD) insurance payouts may be taxable in the fund.
- Payments from insurance may be trapped in the fund.
Insurance cover does not have to be held within superannuation as it is also possible for an individual to take out a policy in their own name. There are advantages and disadvantages with either form of ownership, and these issues need to be considered.
The above information highlights:
- the need for specialised advice to ensure that you (and your SMSF members) are adequately covered,
- that the SMSF meets its obligations in terms of protecting fund managers, and
- that the policy ownership is correct given the individual needs and circumstances of the fund members.
The requirement that trustees evidence consideration of insurance, while not requiring actual cover, is in itself indicative that the regulator recognises that insurance held within an SMSF may not suit every circumstance. While the small percentage of SMSFs with insurance protection may be a reflection of a lack of consideration of insurance needs or a lack of understanding of insurance, it may also be as a result of a rational weighing up of the pros and cons and a considered determination that there are better avenues for holding insurance than through their SMSF.
Speak to one of Capitol Group’s Financial Planners for more information.