Should your life and disability insurance be inside super?

Life insurance is a must-have for many of us, or it should be. It can replace lost income if we’re off work sick or injured or provide a lump sum for disability, death or trauma.

Choosing the type and level of cover you need is one part of the puzzle but another frequently overlooked issue is choosing where to hold your insurance – inside or outside super.

Making the right choice for your circumstances could not only save you money, but also set your mind at ease that you and your family have protection if the worst happens.

Cost

The price of insurance is often a top priority and premiums in super are often lower than for individual policies held outside super.

One reason for this is that large super funds have bargaining power. We’re all familiar with the concept of a discount if you can buy in bulk. Insurers will provide their lowest prices to win a super fund’s business because they can obtain hundreds of thousands of customers (if not millions) at once.

Another reason is that built-in upfront commissions are up to 60% of the first year’s premium and 20% of the premium in subsequent years for policies issued outside super. There is no such cost for policies inside super because commissions were banned in 2013.

If you don’t have the cashflow to pay premiums, the costs of cover can be deducted from your super account balance rather than making additional contributions to fund the deductions. It’s important to remember, though, that the cost of insurance will reduce the final balance you have available for retirement.

Tax-deductible premiums

All insurance premiums are tax deductible for super funds. Outside super, only income protection premiums are tax deductible. This tax deduction further reduces the cost of death and total and permanent disability (TPD) insurance inside super versus outside.

You can also make salary sacrifice or tax-deductible contributions to your account, which can help to meet the cost of premium deductions and reduce your taxable income at the same time.

Accessibility

Most super funds will provide a basic level of cover automatically when you join through an employer, without the need to provide evidence of your health. This is called ‘automatic acceptance’. You may also be able to apply for limited additional cover that will be automatically accepted if you apply when first joining the fund.

Automatic acceptance usually only applies if you join the fund when you first start work with the sponsoring employer, and you must be at work (not away on sick leave) on your first day of employment. This rule gives the insurer some certainty because if you are well enough to get a new job and attend on your first day, then you should be relatively low risk to insure without asking more questions.

While automatic acceptance makes cover in super easier and simpler to get, the level of cover it provides may not be enough for your needs. If you require additional insurance, you will need to apply and complete a health questionnaire just as you would for cover outside the system.

Available types of cover

Regulations mean that the insurance offered inside super must only cover circumstances that would allow the payment to be released in cash – known as conditions of release. This prevents insurance benefits being paid into a fund that cannot then be released – leaving the individual with money stuck inside super that can’t be used for expenses associated with the insured event.

The restriction has different implications for each type of cover in the super system.

Trauma

No new trauma policies are available in super. If you want to apply for this type of cover, you will need to set this up outside the system.

Total and permanent disability (TPD)

Cover is available in super but can only be paid to you if your ill health makes it unlikely you will return to work in an occupation you are suited to because of your education, training or experience.

Outside super, you can usually obtain TPD cover with an ‘own occupation’ definition, which means your insurance is paid to you if you can’t return to your own job, even if you would be fit for an alternative position that you’re qualified for.

Own occupation cover might be important to you if your earnings rely on continuing in your current role. For example, a surgeon may have excellent earning potential. If they suffered a disability that made surgery impossible but would allow them to transition to a role selling specialist surgical tools an ‘own occupation’ policy would pay out while a ‘suitable occupation’ policy in super would not.

Income protection

In super, income protection may only replace lost earnings due to illness or injury and can’t be paid for longer than you are away from work due to incapacity.

Outside the system, some policies offer limited additional benefits such as a defined period of payments for certain injuries even if you can return to work early. Older policies may also cover an ‘agreed value’ of income that is higher than your actual earnings. Or they may pay out more than your earnings at the time of claim via additional benefits for services such as rehabilitation and home care, so be sure to check before you cancel any existing cover.

Since reform in 2020 and 2021, new income protection policies outside super are subject to similar restrictions as inside the system, with requirements that they only cover actual income and that benefits must not exceed 90% of earnings for the first six months and 70% of earnings after that. As a result, there is now little difference between the cover available inside and outside super for new customers.

Death

Death (or life) insurance is generally offered only up to age 65 in super. Outside the system, you may be able to purchase life insurance that will continue to provide benefits beyond retirement age.

Is the cover in super too low or poor quality?

In the past, super funds often offered lower levels of cover than were available outside the system. The features available were frequently inflexible too – for example, income protection was often restricted to a maximum two-year payment period.

As the industry has matured and become more competitive, these issues have largely disappeared. Most funds will offer maximum cover for TPD of at least $2–3 million, and some can provide unlimited amounts of death cover. Income protection is usually flexible, allowing you to choose your waiting period (the time you must be off work before payments start) and benefit period (the number of years payments will continue if you remain disabled).

While the automatic level of cover you are issued with is generally low, you should be able to apply for additional insurance to suit your needs.

Tax on benefits

A very important consideration when deciding whether to hold insurance in super is the tax that applies to the benefits you or your family will receive when an insurance claim is successful.

In the case of income protection insurance, payments are taxed at your marginal rate no matter their source (super or non-super policy).

The issue is unfortunately not so simple for death and TPD cover. Outside super, insurance proceeds for these types of cover are generally tax free, no matter who they are paid to.  

In super, if a death benefit is paid to a beneficiary that is not a tax dependant (such as an adult child), then the payment will be taxed. Payments to a tax dependant (including your spouse, child under 18 or person financially dependent on you) are tax free.

Tax also applies to TPD proceeds from super. The proportion of tax you pay tends to be lower the younger you are when the disability occurs.

Tax on payments doesn’t necessarily mean super is not the place to hold your cover. Financial advisers will often ‘gross up’ the cover they recommend inside super, so the after-tax payment is sufficient for their clients’ needs. The higher level of cover required can still be less expensive than a lower-value policy outside the system because of the lower premium cost in super and the tax-deductibility of insurance premiums.

Seeking specialist advice can help you decide, and a quick internet search may even net you a calculator or two that you can use to estimate tax and the amount of cover you need to make sure your after-tax payment is sufficient.

Restricted beneficiaries

The laws surrounding super place restrictions on who can be paid the balance of your account and any life insurance after you pass away. Eligible beneficiaries include your spouse, children, anyone financially dependent on you and those you are interdependent with.

This may seem restrictive but it is also possible to nominate your legal personal representative (the executor of your estate) who will then distribute the funds to anyone nominated in your will. By going via the estate, any person you choose can receive the funds.

Remember that if the person inheriting the money is not a dependent according to the ATO, there will be tax to pay.

Outside super you may nominate any person to directly receive your life insurance tax free. This can be simpler than holding cover in super if you want the proceeds to go to a person who is not dependent on you.

The bottom line

Insurance in super can be inexpensive, and tax-deductible premiums can save you even more, but restrictions on the type of cover available and potential tax on payouts for death and permanent disability can be unattractive.

Run your numbers and if you’re unsure of the best course for you, talk to a professional adviser for a personal recommendation.