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Insurance in super, sounds great…. What about the taxation of benefits?

Since 2008 employer sponsored superannuation funds have been required to offer Life insurance.  Total and Permanent Disability (TPD) insurance is also often included in the offer  with limited Income Protection less frequently included in employer sponsored super funds.

There are certainly benefits to holding insurance within the superannuation environment and funding the insurance premiums via your superannuation account is one.  With family budgets being stretched ever more tightly and insurance premiums on the rise, this is often the only alternative to provide the coverage needed for your family. Insurance premiums paid via superannuation are automatically deducted and some funds offer limited cover without requiring health checks.

There are however, disadvantages to holding insurance within superannuation. Usually the benefit amounts offered for Life and TPD insurance by employer sponsored super are low. The limitation of cover is particularly relevant for Income Protection insurance offered by the superannuation fund. Consider the benefit period as this is most commonly two years and the cover itself,  is  likely a basic level policy. For Life and TPD insurance, if you or your dependants need to claim on the cover held within a superannuation fund, the release of benefits can take longer than expected as the trustee of the fund must approve the release before provision is paid  to you, your dependants or estate.  The balance of your superannuation fund is reduced by the premiums for the insurance, and last but not least, the taxation of insurance benefits held within superannuation is different to insurance outside of superannuation.

For Life insurance held outside of superannuation, unless this is a policy for business purposes, the benefit is not taxed.

When Life insurance is within superannuation, the benefit may be taxed.  This is really worth reviewing as your family may receive less benefit than you thought they would. To generalise, to avoid tax implications for Life insurance inside superannuation the beneficiaries need to be deemed to be dependant on you; the person insured (for taxation purposes a very simplified definition of a dependant is your spouse, children either under 18 years of age or who are over 18 but dependant on you). I must stress that this is a simplified definition of a dependant only, the actual definition being far longer, lengthier and inclusive of special provisions for proving dependency. 

How does this effect Life insurance policyholders? If you have nominated the beneficiaries on your Life insurance as non-dependants or your children who are over 18 years old and no longer dependant on you, then think about taking your Life insurance outside of superannuation. Why?  A lump super death benefit that is sourced wholly or partly from insurance proceeds will likely give rise to an “untaxed” component (even if there was not an untaxed component before).The size of this component is formula driven and varies depending upon the stage of your working life at the time of death. The longer you had until retirement the higher the “untaxed” component.

If the beneficiary is a “tax dependant” (eg spouse), then the untaxed component is irrelevant as tax is not incurred.

However, where the nominated beneficiary is a tax non-dependant (adult child) then this “untaxed” component is taxed at 30% . Other components “taxable” would be taxed at 15% and “tax free” component of course stays tax free.

TPD is the insurance short cut for Total Permanent Disablement. This is a benefit paid to you if you become injured, seriously disabled or ill and are unlikely to ever work again. The taxation of a TPD insurance payout within superannuation is complicated.  The amount of TPD benefit paid is based on the date of disablement, the age the insured person was when the disablement occurred and the likely number of days the person would have been able to work had the disablement not occurred. As I said, complicated, without even touching on preservation ages and taxed / untaxed elements of superannuation. There are so many variables to calculate a TPD payment via superannuation that a definite amount or percentage cannot be provided in this article. But, unless withdrawn after 60 years of age, the long and short of TPD insurance within superannuation is that there will always be a tax liability. If, for example, you hold a $500,000 TPD benefit within your superannuation, after taxation, the amount you receive may be reduced.

For TPD policies held outside of superannuation, i.e. those policies that are paid for personally, there is generally no tax on any TPD claim. 

Income Protection insurance outside of superannuation forms a tax deduction for you, again no definite amount or percentage of deduction can be provided as this depends on an individuals rate of taxation. As a general guide at least a third or higher of the premium costs are refunded via your tax return. Should you receive claim payments from an Income Protection policy, the Monthly Benefits received will be assessed as all or part of your taxable income.

Income Protection insurance premiums within superannuation are not claimable as a tax deduction. If you receive Monthly Benefits from a claim made on Income Protection insurance inside of superannuation, the benefits received form part or all of your assessable income.

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