There are good reasons to have insurance in an SMSF

Many people setting up a self-managed superannuation fund for the first time choose to keep their old (retail or industry) fund account open to continue their insurance. But it’s also possible to arrange insurance in an SMSF and I want to explain how that works.

Like all super funds, SMSFs can only pay benefits under specific conditions and therefore can only take out insurance for situations that match those conditions.

Typically, this includes “income protection” (often known as salary continuance) for people who are temporarily disabled and unable to work, life insurance (to provide a benefit for the family of someone who dies) and insurance that provides a payout for someone who becomes permanently disabled or has a terminal medical condition (there are specific definitions for both these terms).

There are several reasons people might arrange insurance via their super rather than taking out a policy personally. One reason – relevant for people in a retail or industry fund – is that it’s often easy to get and inexpensive. This is one of the benefits of being part of a large group where the trustee has arranged bulk terms and conditions for all the members.

This obviously doesn’t apply for an SMSF. Insurance arranged through an SMSF generally involves the same amount of work and cost as taking out a policy personally.

An SMSF allows the types and level of cover to be tailored to exactly meet the needs of the members, and can change over time as circumstances change.

Another reason people arrange insurance through their super fund is that the SMSF is allowed to claim a tax deduction for the premiums. In contrast, that’s not always possible for personal insurance. For example, the premiums for a personal life insurance policy are not tax-deductible to an individual.

The positives

It can also be good for cash flow – the SMSF can pay premiums from the super contributions coming into the fund rather than the member needing to find additional cash each month. And even if only one member is making contributions, the premiums for all members can be funded from that cash flow.

That doesn’t mean everyone in the fund is bearing the cost of someone else’s insurance.

Behind the scenes in the fund’s accounting records, the insurance premiums for each member will be specifically deducted from their member account.

So there are good reasons to have insurance in an SMSF.

But to get all these great benefits, it’s critical that the policy is actually owned by the SMSF and the premiums are paid by the SMSF.

These two points have ramifications of their own.

For example, the fact that the SMSF owns the policy also means that in the (hopefully unlikely) event that a claim is made, the money will go to the fund, not directly to the member or their family. And that has a number of important ramifications.

While the insurance proceeds won’t be taxed when they’re received by the fund, they will ultimately translate into a super benefit paid to a member or beneficiary. There might be tax on that benefit.

For example, Chris is 60 and has life insurance in his super fund. Death benefits are tax-free to some beneficiaries (for example, a lump sum paid to a spouse) but not everyone.

What if Chris isn’t married and his super goes to his adult, financially independent, children? They will pay tax at quite high rates on at least some of his super – even up to 30 per cent (plus Medicare if applicable) on some parts.

Things can get tricky

This will flow through to effectively paying tax on at least some (possibly all) of the insurance payout. In contrast, if Chris had arranged this insurance personally (and paid for it from his own money rather than his SMSF or public super fund), it would have been tax-free to his beneficiaries no
matter who they were.

Of course, often people who don’t have anyone who is financially dependent on them don’t have life insurance. (That makes sense – life insurance is all about making sure the people who depend on you being alive will be OK if you’re not.)

But this can be tricky during the murky years when children are “sort of” still relying on the bank of mum or dad but not quite financially dependent and there’s no spouse to receive the money.

Because who, in fact, owns the policy (the SMSF or the member personally) is critical, auditors will usually check the name of the policy owner and how the premiums are being paid each year.

For example, auditors definitely have a problem if the policy is ostensibly owned by the fund (and premiums are being paid by the fund) but the policy documentation makes it clear the policy is owned by the member personally.

In that case, the payment of premiums is technically a benefit payment to the member (which might be illegal if the member isn’t yet old enough to take money out of super).

Or what if things are the other way around? That is, the premiums are being paid by the member but the policy is actually owned by the fund? In this case, the member is technically making a contribution each time they make a payment.

It pays to think carefully about all these things when it comes to insurance – preferably before the time comes to claim on the policy.

This article was first published in the Australian Financial Review on 15 March 2024.