(03) 9020 2905PORTFOLIO POINT: SMSFs offer trustees the ability to get perfectly flexible super funds – inside and outside super – to meet members’ needs.
Super research house Chant West has released a report that is highly critical of Australia’s managed fund superannuation providers in regards to the costs to members of insurance.
In the last 10-15 years, there has been an increasing amount of attention placed on the costs of fees and charges regarding the investment side of superannuation. That is, the percentage and dollar costs taken up by investment management, platform and adviser fees.
But Chant West principal Warren Chant says there has been no corresponding increase in transparency on the issue of insurance. As a result, the cost of insurance can differ by an incredible factor of 20 times in some circumstances.
While most readers of this column have their own self-managed super fund, many may well have retained at least some money in a previous managed fund super account, or not rolled everything into your SMSF. And one of the reasons for keeping that may well have been for the insurance being offered by the previous industry, corporate or retail super funds.
However, a real positive of SMSFs is that you are not limited to the one insurer on offer with a managed fund super provider. Whether they are retail, industry or corporate fund, there is only ever one insurer backing the super platform.
Their insurance might not be particularly great. It might be expensive. You might, because of the insurer’s views on your occupation, be lumped with higher risk professions and pay more for your insurance than you should.
If you are to remain in managed fund super and your insurance doesn’t cut it, your ONLY choice is to switch super funds. But finding the right insurer, given the sorts of disclosure issues outlined by Chant West, would be nearly impossible, unless you’re a financial adviser and know the difference between one insurer and the next.
It probably doesn’t rate as one of the top reasons for getting into DIY super. But your SMSF gives you almost perfect flexibility with your personal risk insurances. You have far more options than someone with managed fund super – you can choose the insurance that you need, the provider, the options that make sense for you and/or you partner.
And whether you want to hold that insurance inside or outside super.
Insurance is not all about cost. As with anything, the cheapest insurance is not necessarily the best. Insurance is actually, largely, about structure. Today we’ll go through the basics of insurance via a SMSF and the sorts of things to keep in mind when organising your own personal risk insurance and how to use your SMSF to achieve those aims.
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There are four different types of insurance that fit into what we know as “life insurance”. They are: life; total and permanent disability; trauma; and income protection.
Life
Life insurance is pretty simple. You’re either alive, or you’re dead. If you no longer have a pulse, or are no longer capable of fogging up a mirror, then you qualify for a payout.
With retail insurance, which is what you purchase in a SMSF, this amount will probably be indexed each year (your option).
Most industry, government and corporate funds, however, are unit-based. For example, a member may have applied for 10 units of cover at $1 a week each. However, as people age, the units fall in value. Someone who applied for 10 units when they were 40-years-old might have been covered for, say, $800,000. But by the time they are 55, their 10 units is only covering them for $200,000.
Life insurance is tax deductible to a complying superannuation fund. The premiums for personally held life insurance, however, are not.
Total and permanent disability (TPD)
It is probably easiest to think of TPD insurance as accident insurance. It’s largely about losing the ability to use your arms, legs or eyes, or combinations thereof. However, TPD insurance can also cover many illnesses that lead to people becoming totally and permanently disabled. Multiple sclerosis, for example, is one illness which may eventually debilitate a member to the point where they become eligible to make a claim on their TPD insurance.
Most managed fund super will only allow people to take out TPD at a maximum of how much life insurance they have taken. That is, if they have applied for $2 million worth of life insurance, then the most amount of TPD that can be applied for is $2 million.
For people who are single, have no dependents and no substantial debt, life insurance is almost irrelevant. Far more important is how you would look after yourself if you DID NOT die from that car accident. And that is TPD insurance.
With a SMSF, you can take out standalone TPD insurance.TPD insurance is also tax deductible to complying super funds and, like life insurance, is not a tax deduction in your personal name.
However, if you make a TPD claim and the money is paid into super and you wish to take this money out, prior to hitting a condition of release, you may need to pay tax to retrieve money from the fund. With TPD insurance inside super, there is a small risk that you might qualify for a payout from the insurer, but not be able to get the money out of your super fund because the victim’s definition does not meet with the Superannuation Industry Supervision Act definition of TPD.
This occurs in about 1-2% of cases and is a risk of taking TPD insurance inside super. You may be then able to apply on hardship grounds. And in any case, you will be able to get the money when you hit another condition of release later in life.
Trauma
This one is best explained as “illness insurance”. The three major claims are made for heart attack, cancer and stroke. But most insurance policies will cover at least 20 illnesses and many of them will cover more than 40.
Trauma insurance can, technically, be done inside a SMSF. But trustees need to keep an eye on whether or not they are likely to be able to get the lump sum out after a claim.
It is far more likely that you could get a payout from trauma and then have the money stuck inside the super fund. That is, you could be diagnosed with cancer, or suffer a heart attack, and your insurer might well pay the claim into your super fund. But if you don’t meet the SIS Act definition of totally and permanently disabled, or another condition of release, then you might not be able to get the money out to cover you when you need it most.
As a result, putting trauma insurance inside super is probably only something to consider doing when you are not far off meeting a condition of release – that is, older than, say, 53 years of age, when you might be able to get some of the money out through a transition to retirement pension when you turn 55.
Important note: Linked versus standalone policies
More than 99% of managed fund super that offer life and TPD insurance offered linked policies. That is, if you have a $1 million life and TPD policy, both will be cancelled if you have an event that qualifies for a TPD payout.
However, you can take out standalone policies with a SMSF. This can either be done through having the insurances with separate companies, or by purchasing buyback options with the insurance initially.
This is particularly important for young parents. For older couples, with children older than say, 15, linked either/or life and TPD policies might be perfectly suitable.
Income protection
Income protection is designed to provide the insured with up to 75% off their income (potentially with another 10% of their salary paid into super) until a defined age.
Some policies only last for two years, others last for five years. Some will go through until age 60 and others through until age 65.
For example, someone earning $80,000 a year would be able to insure their income for $5000 a month ($60,000 a year), plus another $600 a month being contributed to your super fund so that when you hit 65 on claim, you then have something in your super to access.
Obviously, the longer the cover, the more expensive the premium. Until just a few years ago, the tax deduction for super funds for income protection insurance was limited to coverage of only two years, which meant that most super funds only offered cover up to two years. That rule was changed three years ago.
Unlike the other three insurances discussed, income protection is a tax deduction both inside a super fund and in your personal name. But you will have to pay tax on any income received.
Bruce Brammall is director of Castellan Financial Consulting and author of Debt Man Walking.