By default or by design, many Australians hold insurances through their superannuation. The main benefit of insurance in super is that the premiums can be deducted from your super balance, rather than your personal bank account; but along with this comes many disadvantages, limitations, risks and possible taxes.
How Does Super Insurance Work?
When you apply for insurance cover, you can choose who owns the insurance policy. The owner of the policy is responsible for paying the insurance premiums. For example, you can own life insurances in your personal name, through a business, or through super. Not only is the owner required to pay the premiums but, importantly, the owner also receives the insurance proceeds in the event of a claim. This is something that needs to be considered when determining the purpose of the insurance cover and whose hands the money is intended to end up with.
To explain specifically how super insurance works; an insurance policy is taken out through your superannuation provider. This could be insurance offered by your super fund, it could be cover offered by a life insurance company linked to your super fund, or it could be a super trust policy.
What Does Super Insurance Cover?
There are four main types of personal insurance covers:
- Total & Permanent Disablement (TPD)
- Income Protection / Salary Continuance
However, not all of these are available through superannuation.
What is Death Cover?
Death cover pays a lump sum to the policy owner in the event the insured passes away.
What is TPD Cover?
TPD cover pays a lump sum or income stream to the policy owner in the event the insured suffers a total and permanent physical or mental disability.
What is Trauma Cover?
Trauma cover pays a lump sum to the policy owner in the event the insured suffers a critical illness, as defined by the insurance policy. Examples of a critical illness might be a heart attack, stroke or cancer.
What is Income Protection Cover?
Income Protection insurance provides a replacement income, usually equal to 75% of income, should the insured be unable to work due to injury or illness, either temporarily or permanently.
Each of these types of insurances, apart from Trauma, are available through superannuation. The reason for Trauma cover not being available is that, in order to access superannuation, including insurance proceeds owned within super, you need to meet a superannuation condition of release. Suffering a critical illness is not considered a condition of release and, therefore, trauma insurance is often better owned in your individual name – outside of super.
Types of Insurances in Superannuation
Different types of superannuation funds offer personal life insurances in different ways. Insurance cover through various super funds will vary in quality (breadth of cover), policy wording and cost.
When you open a superannuation account, you may be provided with automatic acceptance insurance cover offered by the super fund itself, or you might be able to apply for cover through one or more specialist life insurance providers.
While the policy features and costs between super funds can vary significantly, the way that insurance within super works is largely the same across all super funds.
Industry Fund Insurance
Many Industry Super Funds offer automatic insurance within super. That is, once you become a member, insurance is automatically put in place for you, without any application process. The level of cover and cost of this insurance is based on your age and occupation type. This type of insurance cover is often referred to as default cover.
Industry Funds also often allow you to apply for voluntary cover. Voluntary cover is an amount in addition to the default cover. You might apply for voluntary cover if you feel that the default cover is not adequate for your needs.
Voluntary cover can also give you more customisation over the policy options. There may be an underwriting process associated with voluntary cover – meaning the super fund may ask more information about your health status and personal information.
Automatic acceptance cover can be a cost-effective way of obtaining basic insurance cover, but there are some things you need to consider.
For example, if insurance offered by a super fund is cheaper than insurance offered by a specialist life insurance company; why do you think that might be? Are payouts guaranteed in all cases? Could the policy wording and breadth of cover be of lower quality? This is definitely something to keep in mind. You might want to look into things a bit further if the policy seems abnormally cheap.
Also, if you hold insurance through an auto-acceptance policy, whereby no questions are asked about your health or personal details, can you imagine the type of risks this insurer may be unknowingly taking on? Surely there is a higher level of claims with this type of insurer compared to an insurer who asks lots of questions and either enforces higher premiums for higher-risk people, excludes certain health conditions for certain individuals or chooses not to insure those of high-risk at all.
Retail Fund Insurance
If you hold your insurance and superannuation through a retail super fund, you often have access to insurance cover offered by one or more specialist life insurance providers.
The premiums payable for insurance offered by these types of life insurance companies can often be higher than cover though an Industry Super Fund; however, the policies will generally be more robust, offering better features, greater breadth of cover and a higher likelihood of a successful claim.
As most Retail Super Funds are owned and operated by a financial institution, the insurance offered by your retail super fund will probably be limited to policies offered by that financial institution. For example, if you have an MLC Superannuation Fund, you might only have access to MLC Life policies. In saying that, though, you can arrange your superannuation insurance through another provider and simply perform an annual rollover for the premium amount – giving you more choice of which insurer you go through.
Owning an insurance policy within a self managed superannuation fund (SMSF) gives you the ability to apply for insurance with any insurance provider that you like, because the insurance available is not governed by an external super fund trustee. Instead, you are the trustee of your own super and therefore you get to make up the rules, including the rules around products available to the SMSF members.
The unrestricted access to any insurance provider is one of the benefits of holding your super within a SMSF.
Just like insurance through an Industry Super Fund or Retail Super Fund, the premiums for policies held within a SMSF are deducted from your member balance.
Risk of Insurance in Super
For most, the appeal of owning insurance within super is that premiums can be paid from your super balance, which would otherwise be inaccessible. Though there are other benefits too.
But for now, the risks:
The largest risk of owning insurance within super is accessibility. You own insurance for the sole purpose of being provided with money from your insurer when you most need it. Hey, that’s what you’ve been paying premiums for!
In saying that, obviously the best insurance policy is the one you never need to claim on.
However, should the unthinkable happen, you want to ensure you have immediate access to the funds, right? Now, if you own the policy in your own name, then there’s no problem, because the insurer will pay the benefits directly to your bank account. But, with a super owned policy, the benefits are paid into your super account. This means you need to satisfy a condition of release prior to accessing the funds.
Accessing Insurance Proceeds in Super
Death, total and permanent disability and temporary incapacity are all forms of conditions of release, providing you with access to your super. However, it is possible that the superannuation definition of each term may be different to the insurance policy definition. The result of this may mean the insurance proceeds are paid into your super account (because you met the policy definition), but you can’t access them immediately because you haven’t met the superannuation definition! While this is not common, it is possible.
Tax on Insurance Proceeds in Super
You also want to consider the tax implications of holding insurance within super. In some cases, the proceeds will be assessed for tax. This is determined by the type of insurance, your age at claim and/or the age and relationship of your beneficiary (in the event of death).
Benefits of Insurance Through Super
Holding insurance within super allows premiums to be deducted from your super balance, which can reduce the stress on your personal cash flow. Premiums may also be tax deductible within super and/or contributions to pay for insurance premiums can be tax deductible to you personally.
There can also be estate planning benefits of holding insurance through super, by having greater control over who receives proceeds in the event of your death, or even having the proceeds remain within super and paid as an income stream to your beneficiary.
Regardless of how you hold your insurance policy, whether it be through super or not; it is important to understand the conditions of your cover by reading the Product Disclosure Statement (PDS) offered by your superannuation and insurance provider.
Also, completing an insurance needs analysis can help you determine how much cover you actually need. Working with a professional such as a financial planner or life insurance broker to achieve this is highly recommended.
Our financial planning firm, Toro Wealth, specialises solely in helping 50 to 70 year olds optimise their financial position in the lead up to retirement. If you’re interested in learning more about our service and cost, click here.