Trauma or disability insurance – act before July 2014

SMSF technical expert and columnist for The Australian newspaper
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The types of insurances your super fund can buy will change from 1 July 2014.

From this date it won’t be possible to purchase new trauma and ‘own occupation’ disability insurance policies, which have become quite fashionable for SMSFs.

This new rule will be an operating standard for super funds. A failure to comply with these standards will lead to the Australian Taxation Office imposing an administrative penalty of $3,400 for an individual and $17,000 for corporations. If a fund breaches this new rule, the ATO will also be able to seek additional penalties against a fund, for example by removing a fund’s complying status, or fines against the trustee.

Trauma problems

Trauma insurance will pay out when you suffer one of a defined range of medical problems. Typically these insurances cover heart attacks, strokes, brain tumours, liver failure and so on.

If your super fund buys trauma insurance, it’s quite possible that your fund won’t be able to pay that benefit out of the fund because you don’t meet a condition of release such as death, or temporary or permanent disablement.

Increasingly, people who suffer medical traumas stop work for a period of time to recuperate, and receive intense medical and other treatments, but after one or two years return to work part-time and then full-time once they’re fully recuperated.

If your trust deed allows your fund to purchase a trauma insurance policy, any claim proceeds would be used for at least two purposes. Firstly, some of the proceeds could be used to make notional super contributions for you whilst you aren’t working. In addition, some of the policy proceeds could be used to pay temporary disablement benefits to you while you can’t work.

To solve the problem of trauma insurance benefits being locked in super funds, I have heard that one large life insurance and fund management organisation recommends transferring the ownership of a trauma insurance policy from the super fund to the fund’s member just before a claim is made. On the face of it, this sounds like a sensible suggestion but I suspect capital gains tax may have to be paid by the super fund because at that point it’s disposing of a valuable asset.

Act before July 2014

Own occupation disablement insurance will normally pay a benefit when you can’t perform your current job. This doesn’t mean, however, that you’re permanently disabled under the super laws. In simple terms, these laws only allow a permanent invalidity benefit to be paid to you if your super fund trustee decides that you’ll never again perform a similar occupation to your current job.

It’s possible, therefore, that own occupation disability insurance proceeds can be trapped in your super fund and can’t be paid out, because whilst you might not be able to perform your current job, you could perform a similar one. For example if a surgeon injured their hand, they would no longer be able to operate as a surgeon but there are plenty of other occupations they could carry out.

If a person joins your fund before July 2014, then it will be possible to put in place trauma and own occupation disability insurances for them before that date and keep it in place after June 2014. Unfortunately, this change means that July 2014 will become another messy transitional date that everyone needs to keep in the back of their mind while running their fund.

For now, it would be a useful exercise to review what life insurance policies you currently own in super. If you would like your super fund to own a trauma insurance policy or own occupation disability insurance policy, then you’ll need to put this insurance contract in place before July 2014.

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.

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