Many of us hold life insurance through our super funds and are aware of the tax advantages of doing so. But what are the limitations of structuring insurance in this way?
As Australians, we’re lucky to have one of the best superannuation systems globally. Millions of us hold life insurance policies through our super fund, providing lump sum benefits on death or total & permanent disability (TPD), along with short-term disability insurance (income protection). These policies make up about 70% of all insurance cover and is the reason most of us have some form of life insurance in place.
The benefits of holding insurance through super are numerous. Due to their scale, super funds can purchase policies in bulk and negotiate favourable pricing from insurance providers and pass on these competitive rates to members. Insurance inside super often offers automatic acceptance, which means that no medical or disclosure of pre-existing conditions is required. The ability to pay premiums from your super and not from your after-tax income also makes it an attractive way to access cover.
Equally, holding insurance through a super environment has some limitations. In this article we compare the merits and pitfalls of both approaches.
If you or your employer makes pre-tax contributions to your super fund and your fund deducts a premium for life and TPD insurance from your super account, the premium is effectively paid from your pre-tax income. Pre-tax contributions include compulsory super guarantee and salary sacrifice contributions made by your employer and personal deductible contributions made by you. These are taxed at just 15% within the fund, which could result in significant cost savings when compared to paying for premiums outside of super, with after-tax income.
Most super funds offer a basic level of life and TPD cover without needing you to complete a medical questionnaire to assess the risk of insuring you (known as ‘medical underwriting’). This makes it easy to obtain a basic level of life and TPD cover and can be beneficial if you have pre-existing health issues.
If you want to take out extra cover above the standard level through your super fund, you may need to undergo medical underwriting. It is always worthwhile checking the Product Disclosure Statement of your insurance carefully to see whether you’ll be covered for any existing medical conditions you may have.
Super funds offered to the public usually have large memberships and can negotiate group discounts on the life insurance premiums offered. This does not always mean that the insurance premiums are cheaper than equivalent insurance cover you arrange outside of super, but it means that the premiums may well be competitively priced.
When you have life insurance through super, the premiums are deducted from your super account balance, rather than out of your bank account. If you have other financial commitments such as a home loan or large family expenses, then having premiums deducted from your super may make it easier on your immediate cash flow, though it would still come out of your retirement savings.
Only life, TPD and income protection insurance is available in super. You cannot have trauma insurance in super, which covers you if you suffer a critical medical diagnosis or illness. TPD insurance in super is generally only payable if you suffer injury or illness and are unlikely to ever work again in ‘any occupation for which you are reasonably qualified’.
Outside of super, you may be able to get TPD insurance which covers you, if you are unlikely to work in your ‘own’ occupation because of injury or illness, which might be more appropriate for you depending on your personal circumstances. If you choose income protection in super, the cover is often more basic compared to cover you might be able to get outside of super.
TPD and life insurance proceeds received from your super fund may be taxed depending on your or your beneficiary’s circumstances. If you own life insurance or TPD insurance outside of super, the proceeds are generally not taxed.
Insurance premiums paid from your super account reduces your super balance which may affect your balance at retirement.
The basic level of life insurance coverage inside super is typically very low compared to the needs of some Australians. This means it may not be enough for you, depending on your circumstances. You can also calculate a rough amount you may need by considering the debts you currently hold, your long-term financial obligations (such as the cost of raising children) and the amount of money required to provide your family with their current standard of living.
If you have insurance in super, you need to ensure that you or your employer continues to make contributions to your super fund, as your insurance may be automatically cancelled if your account becomes ‘inactive’ and hasn’t received contributions for at least 16 months. If you want to keep your insurance, you’ll need to advise the fund you want to opt-in to retain the cover, as opposed to insurance outside of super which continues as long as you keep paying the premiums.
The trustee of the super fund owns the policy and may make changes to the policy including changes to definitions and payment terms. Holding insurance outside of super means that, provided the premiums are paid, the terms of the policy don’t change.