Understanding vital to adequate cover

A few questions. Hands up if you know you have life insurance cover in your superannuation? It is safe to say that in any meeting maybe four out of 10 people will have their hands raised.

Hands up if you know how much life insurance cover is in your super? There will probably be fewer hands showing.

Finally, hands up if your life insurance cover in super is enough to meet the financial needs of your family should something happen?

At best guess, there will only be one hand raised in any meeting.

Work done on underinsurance for the Investment and Financial Services Association (IFSA) by Rice Walker Actuaries and TNS Australia last year estimated that around 5.4 million families in Australia are exposed to the risk of financial hardship should either parent die.

In dollar terms, the underinsurance gap — the difference between the cover held and the cover needed to protect against financial risk if things go bad — is now put at around $1.370 trillion.

Many people often feel comforted by the insurance offered by their super fund. However, Rice Walker Actuaries estimates insurance cover through super is only about 20 per cent of what is needed.

Most in-super life cover is generally at a nominal level and may not go even part of the way to meeting the mortgage. Under the superannuation guarantee charge, in-super life at around $1 a week gives cover of less than $100,000 when the average mortgage is more than $200,000 and new mortgages are over $300,000.

There are some advantages having in-super life cover — provided it is of a sufficient level and structured properly.

The co-contribution may be accessible, providing up to $1,500 from the Government.

Salary sacrifice is also available meaning you are paying premiums in pre-tax dollars. However, this is not tax-free as it is still subject to the 15 per cent contributions tax (although a 15 per cent tax rate may be better than your marginal rate of tax).

The self-employed can get a tax deduction for making a contribution to superannuation to fund the cost of personal insurance.

Cash flow problems often prevent people from paying for insurance — but when insurance is structured through superannuation the premiums are taken from the superannuation account balance.

A superannuation fund may have the option of paying a death benefit as a pension, which can deal with excessive benefits in a tax effective manner. This can also be appropriate for spendthrift beneficiaries or children in some cases.

But there are disadvantages and in-super life cover is probably not so well understood or utilised because it can be very complex. It may also discourage others, as the policyowner is not the individual but the trustee.

The following is an example of the complexity of in-super. When a death benefit is paid as a lump sum from super to a dependant (for tax purposes) they will receive up to the deceased member’s pension reasonable benefit limits (RBL) tax free, and any excess will be taxed at 38 per cent plus Medicare levy and/or 47 per cent plus Medicare levy. This is really only an issue if the member is in danger of exceeding their pension RBL — not a very common event.

However, in working out which excessive tax rate applies (ie, 38 per cent and/or 47 per cent) to lump sums over the deceased’s pension RBL, the portion of the excessive benefit that reflects the taxed element of the post-June 1983 component will be taxed at 38 per cent plus the Medicare Levy. The remainder (eg, pre-July 1983 and/or post-June 1983 untaxed element) is then to be taxed at 47 per cent plus Medicare levy.

When a death benefit is paid as a lump sum to a non-dependant (such as a child 18 or over) it is taxed as an ordinary eligible termination payment (ETP) up to the deceased member’s pension RBL. However, note that the ETP tax-free threshold is not available.

As in the case of dependants (for tax purposes), any excessive portion of the death benefit will be taxed at 38 per cent plus Medicare levy and/or 47 per cent plus Medicare levy.

To add another layer of complexity, previously received benefits and accumulated superannuation balances of the deceased paid as death benefits are also counted towards the deceased’s pension RBL. These will also need to be indexed when they are received 12 months or more prior to death.

To index previously received benefits the formula in Table 1 is used.

For members who have their own occupation total and permanent disability cover in-super, there is an issue of whether the member will satisfy the condition of release for permanent incapacity. A member still able to work in gainful employment where they are reasonably qualified by education, training or experience would probably not meet this specific condition of release.

If they don’t meet this condition of release they may still be able to access the entire benefit as a lump sum if they meet one of the following conditions:

* attain age 65;

* terminate an arrangement of gainful employment on or after age 60; or

* attain preservation age, terminate an arrangement of gainful employment and the trustee is reasonably satisfied that the member intends never to become gainfully employed again on a part time or full time basis.

The taxation treatment of a TPD benefit paid as a lump sum from a superannuation fund largely depends on the age of the member and if the member is eligible for the post-June 1994 invalidity component.

Their age is important as there may be a discounted lump sum RBL if they are less than 55 years of age. Depending on age, this could mean only a relatively small part of the taxable benefit (if any) being paid at concessional tax rates, with the rest becoming an excessive benefit and taxed at either 38 per cent plus Medicare levy (for those benefits representing a post-June 1983 taxed element) or 47 per cent plus Medicare levy.

For members that qualify for a post-June 1994 invalidity component it becomes a more generous tax-free when withdrawn as a lump sum from a superannuation fund and does not count towards their RBL.

Any remaining portion is likely to be pre-July 1983 and/or post-June 1983 components. If these are withdrawn as a lump sum they may be taxed and counted towards the member’s RBL.

Another factor to consider is that it is very rare for critical illness (trauma) insurance to be offered in superannuation. This only further enlarges the underinsurance gap given the likelihood of suffering a critical illness as opposed to other events.

In-super life cover has its advantages and disadvantages and must be looked at on a case-by-case basis to make it work the best. However, what is not complex and not subject to question is that present life cover — in super and outside of super, is not enough to protect an individual’s wealth and family.

Carly O’Keefe is manager, superannuation, Tower Australia.