How should I hold my life insurance?

Holding your life insurance policy through your super fund is not always as “tax-effective” as you may think.

You need to think past the “deduction” for premiums.

The good news

First the good news.

Funding life insurance premiums through super can be tax effective because concessional contributions used to pay premiums are not subject to the 15% contributions tax, and you still get a deduction (or reduced income) from making the contribution. You effectively get a “tax subsidy” for funding the premiums through super.

Furthermore, by paying your premiums from your super contributions and savings, you can reduce pressure on your own personal (non-super) cash flow. Premiums can be paid using superannuation guarantee contributions, investment earnings and accumulated benefits.  However, this will of course have a negative impact on the overall level of savings left over for your retirement.

You may also be able to benefit from cheaper insurance premiums if you are with a super fund that has the ability to buy in bulk and thereby negotiate lower premiums for its members.

Another key benefit is that the payment of a death benefit from a super fund to a “tax dependent” is tax-free. A tax dependent includes your spouse, a child under the age of 18 or a person who is financially dependent on you at the time of your death.

The not so good news

Now for the not so good news.

The payment of a death benefit from a super fund to someone who is not a tax dependent is subject to tax. The rate of tax is either 16.5% or 31.5% of the gross death benefit paid. Which rate applies depends on how long you have maintained the super account before taking up the policy, relative to your normal retirement age.

For example, Mark held a life insurance policy through his super fund and died at age 45. The super fund claimed a deduction for the insurance premiums. The super fund received a $1 million payout on the policy on Mark’s death, and in turn paid this as a death benefit to Mark’s 22 year old daughter Lesley. Mark started the super 10 years ago, when he was 35.

Given that the death benefit is paid to his adult daughter who is not a tax dependent, tax will apply to the death benefit as follows:

The taxed component is calculated as follows:

10 years of eligible service (from age 35 to 45)

30 years of total service period (normally up to age 65) – from 35 to 65

$1,000,000 x (10/30) = $333,333

The untaxed component is calculated as follows:

$1,000,000 – $333,333 (i.e. the taxed component) = $666,667

The tax payable on each component is calculated as follows:

Taxed component: $333,333 x 16.5% = $55,000
Untaxed component: $666,667 x 31.5% = $210,000

Total tax payable by Lesley on the death benefit = $265,000

If the benefit had been paid to Mark’s spouse or dependent child, then no tax would have been paid on the death benefit.  If Mark had held the policy outside of his super fund, no tax would have been payable on the benefit.

Accordingly, if you do not have a tax dependent then it may be appropriate to hold the policy outside of super. Factors that you need to consider include:

  • Whether you have any tax dependents, or are likely to at the time of your death;
  • Whether you wish to pay any death benefit to your tax dependents;
  • The cost of your premiums, and therefore the tax benefit of getting a deduction for your premiums;
  • The level of death cover;
  • The time you have held your super fund account; and
  • Your current age relative to your retirement age.

Another thing to consider is that the trustee of your super fund ordinarily has a discretion as to which of your super dependents they pay the death benefit to.  You can override this discretion by giving the trustee a binding death benefit nomination.

It is also worth noting that payouts can take longer through a public offer super fund. This is because the life insurance company pays to the super fund trustee, who in turn must then make a death benefit payment in accordance with the super funds rules and any nominations in place.

To make sure you maximize the after-tax proceeds received by your family, please call Andrew Andreyev on 1300 654 590, or email him at andrew@andreyev.com.au.

If you require advice on life insurance and superannuation more generally, we recommend that you consult your licensed financial adviser.

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