Are you best to hold your life insurance policies inside or outside superannuation?

Well, there are advantages and disadvantages with both approaches.

Before we discuss the merits of both approaches, I will briefly detail the different types of insurance policies.

Overall, there are really four different life insurance policies available:

1. Death insurance – this is quite straightforward; clearly money is payable when you die.

2. Total and Permanent Disability (TPD) insurance pays a lump sum if you can’t work due to physical or mental ill health. In broad terms, there are three different types of disability – one where the insurer determines that it is unlikely you will ever do any future work; another where the insurer decides if it’s unlikely you’ll be able to do a job which involves your training and years of experience; and the last which you will receive a lump sum payment if you can’t do your own occupation or something very similar to it.

3. Salary Continuance, which pays you an insurance benefit in the form of regular monthly installments if you can’t work due to physical or mental ill health; the definitions of disability used for this insurance are similar to that used for TPD insurance.

4. Trauma Insurance pays a lump sum, if you were to suffer some type of medical problem, such as heart attack, various cancers, brain tumours and major organ failure.

There are about 28 life insurers operating in Australia and some of them will use different names for their insurance products than I have above.

Often these types of insurances can be purchased as standalone policies or bundled into a single contract.

Now let’s look at which of these insurance policies can be purchased in superannuation.

The major restriction is that your self-managed superannuation fund (SMSF) can’t purchase any insurance policy, if claim proceeds can’t be paid out immediately.

For example, suppose your fund’s trust deed didn’t allow any death benefit proceeds to be payable (admittedly this would be an unusual provision.) But if this were the case, your fund wouldn’t be allowed to purchase a death insurance policy. There is a concession to this rule, however, if your fund purchased a policy before 1 July 2014.

Insurance outside of super

The primary reason you might insure outside super is that if the policy is owned by you personally, then any claim proceeds are paid to you tax free. In other words, it can seem simple.

However, in this situation, other than death benefits, all the proceeds would be paid to you personally. In the event of financial difficulty, you might have to use this money to settle debts and other obligations.

In addition, any death benefit proceeds that are paid to your estate can be subject to challenge by dissatisfied or disgruntled beneficiaries.

The negatives with insurance outside super are that there are no potential tax savings on any contributions you make to super to cover the cost of the insurance. This can be a big deal for those relying on employer super contributions to help meet the cost of this insurance.

Insurance in super

One of the advantages of insurance in super is that you can use tax concessions on contributions to effectively reduce the cost of the insurance policies.

As noted above, those who find cash flow tight can rely on employer contributions – both compulsory and/or salary sacrifice contributions – to pay for the insurance.

One advantage of insurance inside super is that sometimes you can delay paying benefits in the event of your financial difficulty, thereby potentially avoiding the need to pay creditors. (This is the exact reverse of the situation that can arise for personally-owned super policies above.)

One disadvantage with holding insurance inside super is the two-step claims process.

Let’s suppose your SMSF owns a TPD policy. In the initial instance, you claim a benefit from your super fund.

Your fund trustee then assesses you according to your trust deed. At the same time, it would seek to claim from the insurance policy. Both assessment processes must be run independently of each other.

Your insurer might ask for medical and other information that your super fund doesn’t need or want and vice versa.

Another disadvantage with insurance inside super involving death insurance involves the payment of that benefit and your survivors working their way through the fund’s trust deed, any benefit nominations you have completed and dealing with any conflicts. This is an area of increasing litigation. The only way to avoid this is with very careful planning.

5 other issues to consider

1. Stepped or level premium – most life insurers offer two types of premiums – stepped, which increase each year based on your age, and level, which remains unchanged for the life of the policy. Initially, level premiums will be more expensive but, over time, will become cheaper.
2. Underwriting – medical and occupational underwriting can be a pain in the neck. Most industry super funds offer cheaper insurance than other market offerings and also allow you to increase your insurance amount without underwriting when you first join the fund. That said, because the insurance is cheap, it doesn’t mean it will suit your purposes or needs.
3. Insurance for business purposes – insuring against business succession and key employee risk are complex issues and many of the issues that need to be considered haven’t been canvassed here – perhaps a piece for another article!
4. Insurance is a contract – remember that all insurances are a contract and, by definition, the wording of that contract is very important; you need to make sure that the contract will pay you a benefit when you expect it.
5. Don’t buy solely on price – value is important but a lower price is often an indication of greater restrictions on paying you a benefit

Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.