The purpose of life insurance is to provide cash for some person or some purpose when you die. It is therefore surprising how many people fail to plan to ensure their objective is met. There are some tricks and traps to be aware of…
More and more of us are turning to life insurance to provide for our loved ones in the event we unexpectedly die or suffer a debilitating condition.
Life insurance provides a cash payment in the event of your death. The policy may also provide a payment if you are permanently disabled or suffer a critical illness. The payment can be used to support your spouse and children, pay down debts, or serve some other Estate Planning purpose, such as meeting tax obligations, providing cash to a beneficiary in lieu of other assets, or giving money to charity.
You can either hold your life insurance through a policy taken out personally, or through your super fund.
However, it is surprising how many of us have not properly considered the consequences of how we hold our life insurance. You need to take the time to consider who will receive the proceeds from your policy, and how to minimise taxes and other claims on the cash.
There are a number of traps to be aware of and plan around, to ensure that your dependants are properly looked after as intended.
Who will receive the proceeds from your policy?
If you take out life insurance an important consideration is who will receive the proceeds. There are some traps, which could mean the difference between the money going directly to your family, or being used to pay outstanding debts and obligations.
Holding the policy in your own name:
If you are the owner of the policy, the proceeds will go to your Estate and be dealt with under your Will. Accordingly, you must specify who is to receive those proceeds in your Will. If your Will is silent on the issue, the proceeds will form part of your “residual Estate” and be paid to your residual beneficiaries.
If you have outstanding debts or other claims against you at the time you die then your Estate assets (including the proceeds from the policy) may be used to pay these debts and obligations, which may mean that your dependants miss out.
Furthermore, a person who is not adequately provided for in your Will may challenge your Will, and thereby potentially take a larger portion of the insurance proceeds than you intended.
Naming a beneficiary to receive the proceeds:
If instead you name a beneficiary under the policy, the proceeds will not be paid to your Estate. Instead they will by-pass your Estate and go directly to the named beneficiary. For example, if your spouse owns the policy over your life, the proceeds will be paid directly to your spouse after your death.
If the proceeds go directly to a beneficiary, the beneficiary will receive the proceeds outright at that time. If beneficiary has unsatisfied debts or liabilities, the proceeds may be used to satisfy those claims. Furthermore, if the beneficiary is a child, they will be entitled to the full amount of those proceeds when they reach 18, which could be too early for them to properly handle the money.
There is no right or wrong way to deal with a life insurance policy. You need to take into account your own personal circumstances and then structure your affairs accordingly.
Consider using a ‘testamentary trust’ in your Will
If you are going to have the proceeds from life insurance paid to your estate, then you should consider including a testamentary trust within your Will to ensure that your objectives for your life insurance are met. A testamentary trust will:
- Ensure the proceeds are passed to your intended beneficiaries, as and when you direct. For example, you may wish for the proceeds to be paid to young beneficiaries over time;
- Provide capital gains and income tax advantages to your beneficiaries, particularly if the beneficiaries are under 18; and
- Provide a significant level of protection for assets if a beneficiary becomes bankrupt or divorced.
Insurance through super
If you hold a policy of life insurance through your super fund, then you need to consider a number of additional issues.
First, your options regarding who receives the proceeds are more restricted than if the policy is held outside super and the tax considerations are more complex.
You are restricted to nominating either your Estate or a person who qualifies as a “dependant” for superannuation law purposes to receive the super proceeds.
If your nomination is not a valid binding nomination, then the trustee of the super fund has the authority to overrule your nomination to ensure that your benefits are distributed in an appropriate manner.
Furthermore, if the life policy is held through super then there may be an additional layer of tax on the payout to the beneficiary. This will be the case if the beneficiary is not also a “dependent” for tax law purposes, (which is a slightly different definition than for superannuation law purposes).
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