SMSFs and insurance: Rules and considerations

The main benefits of purchasing member insurance through an SMSF are:

1. The premiums are tax deductible from the fund’s earnings in its annual tax return, provided the SMSF is listed as the policy owner and the SMSF member is the insured person. This can reduce the overall cost of the insurance. In contrast, life and TPD premiums are not tax deductible if an SMSF member chooses to have this coverage outside super. Income protection insurance is tax deductible outside super, so the decision to hold it in or out of super will depend on your other circumstances.
2. The premiums are paid by the fund, so a fund member’s personal cash flow isn’t affected.
3. The insurance cover can be more flexible than the group insurance cover that is provided for members of large public super funds in terms of the sum insured and the waiting period. This can help to prevent SMSF members being underinsured.

Taxation of insurance benefits

While tax deductions on the premiums can be attractive, don’t forget to look at the taxation of benefits if you need to make a claim.

While life and TPD benefits received from insurance held personally outside super are generally tax free, there may be tax consequences for policies held inside super.

Life insurance payouts from your SMSF will have different tax implications depending how they are paid and to who. Lump sums paid to tax dependants are tax free, but a lump sum paid to a non-tax dependant is taxed at rates of up to 32%, while income streams may also be taxed, depending on the ages of the deceased and the beneficiary. TPD payouts from super are taxed according to the components of the benefit at the usual tax rates for accessing super, which vary by age. Amounts taken as a lump sum have a ‘tax-free uplift’ amount calculated that reduces this tax.

You can consider holding a higher sum insured inside super than would be needed outside super to ensure the after-tax claim proceeds are sufficient.

Income protection benefits are generally taxable at normal marginal rates no matter how they are received.

Are SMSF insurance premiums competitive?

SMSFs may pay higher premiums than larger public funds because big funds can often negotiate bulk premium discounts with insurance providers. It is also worth noting that many of the insurance policies offered by larger public funds have built in decreasing levels of cover, meaning the insurance cover reduces the older you get.

Some insurance companies offer policies specifically for SMSFs that can allow them to combine and benefit from lower group insurance rates. So potentially, SMSF premiums can be cheaper than (or at the very least comparable to) the premiums that individual members pay when dealing directly with insurance companies.

Can I transfer my personal life insurance policy to my SMSF?

No. Except in limited circumstances, an SMSF is not permitted to acquire assets from a related party. This prohibits your fund from acquiring an insurance policy from you.

Your insurance provider may offer you the option to cancel the policy you currently hold and reissue an equivalent policy to your SMSF without the need for you to go through the usual application process.

You may be charged a fee by your insurance provider for doing this, but you stand to benefit from your SMSF being able to claim your premiums as a tax deduction.

What other types of insurance can SMSFs purchase?

Beyond life insurance, TPD and income protection insurance, there are other types of insurance cover that SMSFs can purchase, including:

• Property insurance. If your SMSF holds residential or commercial property in its investment portfolio, it’s crucial to have adequate property insurance. This helps safeguard the value of the property against damage or destruction.
• Audit protection. If the ATO decides to audit your SMSF, audit protection insurance covers your fund against both the cost of compliance with an audit and any penalties you pay if an error is detected.
• Trustee insurance. This type of cover can help protect an SMSF trustee’s personal assets from legal liability in the event of any serious breaches of their legal obligations.

It’s also worth noting that SMSFs can’t purchase insurance policies for cover such as health insurance because it doesn’t satisfy the sole purpose test. The Australian Taxation Office (ATO) requires super funds to be maintained for the sole purpose of providing retirement benefits to their members (or to their dependants if any of their fund members die before retiring). The provision of income protection falls under an approved ancillary purpose.

The bottom line

SMSFs trustees are legally obliged to consider insurance cover for each member of their fund as part of preparing their fund’s investment strategy. But this doesn’t mean insurance inside your SMSF is compulsory. Members may already have an appropriate level of cover outside the fund, though there are benefits in having insurance inside your SMSF.

Once you decide on the best way to hold insurance, you then need to think carefully about the amount of cover you and your family need and make sure that you keep written evidence around your insurance decisions for your SMSF.

The information contained in this article is general in nature. It’s best to seek independent professional advice to determine whether your SMSF should take out insurance cover that’s appropriate for the specific needs and circumstances of your members as well as any tax implications.