Deductibility of insurance premiums in a SMSF | Accurium

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Introduction

Under section 295465 of the Tax Act1, a superannuation fund can claim, as an income tax deduction, the part of any insurance premium that is specified as being wholly to cover the liability to pay:

  • a superannuation death benefit
  • a terminal medical condition benefit
  • a disability superannuation benefit
  • a temporary disability benefit paid in the form of a non-commutable income stream

This means superannuation funds will generally be able to claim a deduction for the cost of any life, terminal medical condition, total and permanent disability (TPD) or income protection policy held to provide insurance cover for one or more members.  

The portion of an insurance premium that a superannuation fund can claim will depend on the type of policy and what cover that policy provides. The table in s.295-465(1) of the Tax Act outlines the proportions of insurance premiums for different types of policies that can be claimed: 

Type of policy Amount that can be claimed
Whole of Life 30% of the premium
Endowment 10% of the premium
Providing Providing benefits per s.295-460 (life, terminal medical condition, TPD, temporary incapacity) That part of the premium specified in the policy as being wholly for the liability to pay such benefits 

Background

Life and TPD insurance premiums paid by a self-managed superannuation fund (SMSF) prior to 1 July 2007 had always been fully deductible.

However, the ‘Simpler Super’ changes which came into effect from 1 July 2007 introduced (possibly inadvertently) a definition of TPD which was not in the previous legislation. The effect of this addition is that only premiums for insurance policies which contain a TPD definition at least as narrow as the definition in the Tax Act will be fully deductible.

A four year transition period from 1 July 2007 to 30 June 2011 was put in place to allow the industry time to adjust to this change. During this transition period, the pre 2007 rules continued to apply, so that TPD premiums remained fully deductible. 

This means that from 1 July 2011:

  • If the TPD definition matches the Tax Act definition the premium will be fully deductible.
  • If the TPD definition is broader than the definition in the Tax Act the premium will only be partly deductible, with the deductibility either as certified by an actuary, or based on standardised deductible proportions.

Note: For TPD policies taken out from 1 July 2014, they can only provide an insured benefit in relation to a member that is consistent with the TPD condition of release in Schedule 1 (item 103) to the SIS regulations2. Essentially, this means that TPD policies taken out since 1 July 2014 can only include the ‘any occupation’ definition, as this aligns with the definition of ‘permanent capacity’ under SIS regulation 1.03C and which is also consistent with the Tax Act definition, outlined below.

Life insurance premiums remain fully deductible.

TPD definitions

An income tax deduction is available for TPD insurance premiums where the insured benefit provided meets the definition of a ‘disability superannuation benefit’. Under the Tax Act, a ‘disability superannuation benefit’ means a superannuation benefit if:  

(a) The benefit is paid to a person because he or she suffers from ill health (whether physical or mental); and  

(b) Two legally qualified medical practitioners have certified that, because of the ill health, it is unlikely that the person can ever be gainfully employed in a capacity for which he or she is reasonably qualified because of education, experience or training.  

This type of definition is typically characterised as an ‘any occupation’ definition because to meet this definition you need to be unfit not only for your current occupation, but for any other occupation you could reasonably hold.  

As noted above, new TPD policies taken out since 1 July 2014 can only include a definition that is consistent with the condition of release under Schedule 1 (item 103), that is, an ‘any occupation’ definition. For those SMSFs with grandfathered pre 1 July 2014 TPD policies, the definitions included in those TPD policies won’t always match the definition in the Tax Act, which effects the deductibility portion of the premium. Some of the common definitions of TPD you might find in a grandfathered pre 1 July 2014 TPD policy include:

  • Any occupation – you can no longer work in any occupation (which would be consistent with the Tax Act).
  • Own occupation – you can no longer work in your current occupation, but you can work in some other occupation.
  • Loss of limbs – you have lost the use of the specified limb(s), e.g. one arm and one leg.
  • Activities of daily living – you require assistance to complete activities such as dressing, washing and feeding.
  • Domestic (home) duties – you require assistance with cleaning, cooking, shopping and caring for children.  

Each of the last four definitions above are broader than the Tax Act definition, and therefore may require an actuary to certify the proportion of the TPD insurance premium that is deductible. 

Relevant regulations

The government recognised that the requirement to obtain actuarial certification for the deductibility is potentially onerous. Therefore it put in place regulations that allow standardised deductible proportions for the more common TPD definitions that you would find in a grandfathered pre 1 July 2014 TPD policy.  

The standardised deductible proportions of TPD insurance premiums are:

TPD Definition Deductible Part 
Any occupation 100%
Any occupation plus:  

(a) Activities of daily living; (b) Cognitive loss; (c) Loss of limb; (c) Domestic (home) duties.
100%
Own occupation 67%
Own occupation plus:  

(a) Activities of daily living; (b) Cognitive loss; (c) Loss of limb; (c) Domestic (home) duties.
67%
Own occupation bundled* 80%
Own occupation bundled*, plus:  

(a) Activities of daily living; (b) Cognitive loss; (c) Loss of limb; (c) Domestic (home) duties.
80%

* with an amount of cover less than or equal to the amount of death cover.

Note: You still have the option of asking an actuary to certify the deductible proportion.

What you can do now

Here are some practical steps that you can take where you have an SMSF which holds a TPD insurance policy: 

  1. Check to ascertain if the TPD policy was taken out since 1 July 2014. These TPD policies can only contain a definition that is consistent with the permanent incapacity condition of release specified in the SIS regulations. For these TPD policies, premiums will be 100% deductible to the SMSF.

  2. For grandfathered pre 1 July 2014 TPD policies, check the TPD definition and consider how this compares to the definition in the Tax ActIf the TPD definition is not consistent with the condition of release specified in the SIS regulations, the SMSF will be unable to claim 100% of the premiums paid.

  3. For bundled grandfathered pre 1 July 2014 life and TPD policies, talk to your insurer. Are they willing to advise your life insurance and TPD insurance premiums separately? And will their actuary certify the deductible proportion of the TPD premium?

  4. Consider if it makes sense to switch to a TPD policy with a definition that is consistent with the permanent incapacity condition of release specified in the SIS regulationsThis may include consideration of a split TPD policy.

Income Protection - temporary incapacity benefits

Income protection pays a monthly benefit if the insured person is temporarily incapacitated due to injury or illness (whether physical or mental). A waiting period can apply (generally 14 days up to 2 years) with a benefit period of 2 years, 5 years, to age 65, or to age 70.

Generally, premiums for income protection are deductible to a superannuation fund (under s.295-460 of the Tax Act), however, they are also deductible outside of superannuation, that is, where the policy is owned by the member and premiums are paid by them (under s.8-1 of the Tax Act). Given this, ownership outside superannuation is likely to provide a greater tax benefit and may be more appropriate if the objective is to maximise retirement savings. Further, income protection policies outside of superannuation are likely to include more product features than those held inside of superannuation.

Alternate deduction for cost of providing insurance

Under section 295-470 of the Tax Act, a superannuation fund trustee can claim an income tax deduction for the future liability to pay benefits based on the actual cost of providing death or disability benefits that arise. This is an alternate deduction to claiming the actual insurance premiums.

This alternate option is unique to SMSFs as trustees who elect to claim under this option can no longer claim future insurance premiums as an income tax deduction. Large superannuation funds are unlikely to utilise this alternate option as it would deny the superannuation fund from claiming future insurance premiums in respect of all fund members.

To be eligible to claim under the alternate deduction option, the following must apply:

  1. The SMSF trustee must make a choice to not claim insurance premiums and claim under the alternate option. Once the choice is made, the SMSF can no longer claim an income tax deduction for future insurance premiums, including making a future claim under the alternate option.

  2. The benefit paid by the SMSF trustee can be a death benefit payment, a terminal medical condition benefit payment, a permanent incapacity benefit payment or a temporary incapacity benefit payment. Further, the benefit can be paid as a lump sum or as an income stream (pension) [Note: for a temporary incapacity benefit, the SIS condition of release requires the form of the benefit to be a non-commutable income stream].

  3. The member to whom the benefit relates must be under age 65 at the time of the relevant insured event occurring, for example the death of the member. This is due to the relevant formula used to calculate the deduction referencing ‘future service days’ which is regarded as a period up to normal retirement age, being age 65.

  4. There must be an insurance premium paid in the year of death of the memberWith this imind, SMSF trustees should consider whether it would be better to pay monthly premiums rather than annual premiums.

  5. For a benefit in relation to death, terminal medical condition or permanent incapacity, the benefit payment must be in consequence of termination of the member’s employment. This generally requires the member to be employed up until the date of the relevant insured event.

Calculation of deduction

The deduction under the alternate option is calculated using the following formula:

Deduction= benefit amount x future service days
                      total service days 

Where:

  • Benefit amount = amount of death benefit lump sum, account balance of death benefit income stream or value of temporary disability income payments made during year, including insurance proceeds.
  • Future service = days from termination to last retirement date (generally age 65).
  • Total service = existing service period plus future service

Example:

Patrick, a member of an SMSF, dies, age 44:

  • Employed up to date of death.
  • Current service period is 25 years (9,125 days).
  • Future service period is 21 years (7,665 days).
  • Total benefit paid, either lump sum or income stream, to spouse is $1.5m, including $800,000 of insurance proceeds.

Where the SMSF trustee makes the choice to claim under the alternate deduction option, the deduction is calculated as follows:

$1.5mx7,665
(9,125 + 7,665)

Deduction = $684,783

Generally, the size of the deduction means that the SMSF will have a carry forward tax loss and consequently, the following should be considered:

  • The effect of net exempt current pension income (ECPI) on a brought forward tax loss. Net ECPI will reduce a brought forward tax loss prior to applying against current year assessable income.
  • Whether SMSF members with retirement phase pensions should be transferred to another superannuation fund so that the SMSF does not have any ECPI that can reduce the amount of a brought forward tax loss.
  • Whether new members should be introduced to the SMSF and that they direct their assessable contributions to the SMSF so that they can benefit from the brought forward tax loss.
  • Whether members’ insurance cover should be held in another superannuation fund. As the SMSF has made a choice to claim under the alternate deduction option, the SMSF is no longer permitted to claim an income tax deduction for future insurance premiums.

An SMSF that is paying a benefit that prima facie qualifies for the alternate deduction option should consider obtaining specialist tax advice in relation to making a claim.

Claiming insurance in an SMSF with ECPI

The claim for insurance by a superannuation fund under s.295-460 or the alternate s.295-470 of the Tax Act does not require the claim to be apportioned where the superannuation fund claims ECPI. However, as noted, where a superannuation fund claims insurance and this produces a current year tax loss, the brought forward tax loss will be reduced by the superannuation fund’s net ECPI.

Tax act references: 

See sections 295-460, 295-465 and 295-470, contained in volume 6 of the Income Tax Assessment Act 1997. The definition of disability superannuation benefit is in section 995-1 of volume 8.

1. Income Tax Assessment Act 1977
2. Superannuation (Industry) Supervision Regulations 1994

 

 


Disclaimer

This information is provided by Accurium Pty Limited ABN 13 009 492 219 (Accurium). It is factual information only and is not intended to be financial product advice, legal advice or tax advice, and should not be relied upon as such. The information is general in nature and may omit detail that could be significant to your particular circumstances. The information is provided in good faith and derived from sources believed to be accurate and current at the date of publication. While all care has been taken to ensure the information is correct at the time of publishing, superannuation and tax legislation can change from time to time and Accurium is not liable for any loss arising from reliance on this information, including reliance on information that is no longer current. We recommend that you seek appropriate professional advice before making any financial decisions.