How is life insurance taxed in Superannuation?

Life Insurance in superannuation is pretty common and is normally offered automatically when you join. So although people tend to forget they have it or don’t know they have life insurance in superannuation, most people will have some level of cover. In fact since 2008 it has been mandatory for employer sponsored superannuation funds to offer a minimum standard level of Life Insurance in superannuation of up to $50,000.

There are however big difference’s in the way that life insurance policies are taxed when they are in a superannuation fund. Unlike personally owned life insurance policies that are not taxed when a claim is made (unless it is a policy for business purposes), superannuation policies are. When taking out, reviewing or considering life insurance in superannuation a person needs to keep this possible tax in mind otherwise your family may be short at claim!

Superannuation Life Insurance TaxThere are obviously attractions of putting your life insurance in superannuation or an SMSF, like tax deductible premiums. But don’t forget what the government gives you now they probably want back later! By owning life insurance in superannuation, the taxation on claims becomes a little more complex and a few extra conditions need to be met when claims are made.

A superannuation fund can only pay a claim to a narrow scope of people including legal representatives (your estate), children (including step-children, ex-nuptial and adopted), spouses (including de-facto and same sex) and can include ex-spouses. When a claim is paid these people they are either deemed to be; financially dependent (a Taxation Dependent) or a non-dependent (if it is paid to the estate then the person who eventually gets paid it is assessed)

If your beneficiary is classed as ‘financially dependent’ then life insurance proceeds paid from superannuation are paid tax-free. Some beneficiaries are automatically classed as ‘taxation dependents’ and these include current spouses and children under the age of 18. That is the easy part.

A person who isn’t automatically classed as a dependent can apply to be assessed as one (and have no tax payable on the life insurance claim) if they can establish what is called an ‘interdependency relationship’ under s302-200 of the Income Tax Assessment Act 1997. Any beneficiary can apply for this  but to have proceeds paid tax-free ‘intedependency’ must be established and in some circumstances it can be somewhat difficult. In order to establish the relationship, the following must exist;

  • they have a close personal relationship, and
  • they live together, even if they are not related by family, and
  • one or each of them provides the other with financial and domestic support and personal care.

If you cannot convince the ATO or the superannuation fund that an ‘interdependency relationship’ exists then a tax bill won’t be too far behind. This is most common with adult children. It is the life insurance claims paid from superannuation to non-dependents where the tax gets complicated.

Everybody’s superannuation balances are made up of different ‘elements’ and ‘components’ that attract different rates of tax. As these elements and components cannot be altered or changed at claim we won’t discuss how they come about (in an attempt not to complicate it even further!). When a life insurance claim is made from superannuation, the claim will be added to the existing balance and split in the different tax categories that already exist in the superannuation fund. Those are;


Life Insurance in Super Tax Rates

What does this mean? Say for example a person has $100,000 in contributions in their superannuation fund with $10,000 tax-free (10%) and $90,000 taxable (90%). When a life insurance claim is made, the life insurance claim is added to the contributions and is split in the same percentage. In this case 10% of the total will be ‘tax-free’ and 90% will be taxable.

Calculating the taxation liability can be somewhat difficult as the ‘taxed element of the taxable component’ is taxed at 16.5% (including Medicare Levy) and the ‘untaxed element of the taxable component’ is taxed at 31.5% (including Medicare Levy).  Furthermore the percentages that everything gets split up between depends on when the member entered the fund and the time until the member would have retired.

Take this scenario as an example;

Andrew aged 50 suddenly dies of a heart attack on the 1st February 2012. Over his lifetime he has accumulated $300,000 in superannuation assets and was insured for $600,000. Andrew nominated his 22 year old son to receive his entire benefit who is no longer dependant. Andrews son is working part-time, studying at university and lives with friends.

Although the gross amount of benefits left to Andrews son is $900,000, he would receive the following amount after accounting for taxation;

Work out the tax on the ‘untaxed element of the taxable component’
Total Sum x (days from death until notional retirement divided by days from joining fund until notional retirement)
      $900,000 x (5,164 / 13,384) = $347,250
      $347,250 x 31.5% tax = $109,383 tax on ‘untaxed element of the taxable component’
Work out the tax on the ‘taxed element of the taxable component’
Total Amount – Untaxed Element Amount
      $900,000 – $347,250 = $552,750
      $552,750 x 16.5% = $91,203 tax on ‘taxed element of the taxable component’
Total taxation payable = $109,383 + $91,203 = $200,586
Net life insurance from superannuation claim payment = $900,000 – $200,586 = $699,414

*Andrew’s entire balance was comprised of a ‘taxable component.’ He was born 22nd March 1961, joined the fund on the 31st July 1989 and died on the 1st February 2012. The number of days from fund start date to notional retirement is 13,384 days and the number of days from death until national retirement is 5,164 days.

From the example above, Andrew’s son in this scenario would have incurred a taxation liability of $200,586 and would have received a net amount of $699,414. If Andrew did not think or know about this future tax liability or communicate this to his family, then Andrew’s son could be left with a shortfall if the total amount paid did not cover the financial need.

A common question asked regarding superannuation benefits and taxation is what happens if the proceeds are left to the estate? In this case the liability for taxation depends on who ultimately receives the benefits. If they are classed as a ‘taxation dependent’ then no tax will be payable, otherwise if the definition cannot be met, then the end-beneficiary will be liable for taxation.

It is important to consider the taxation implications of life insurance in superannuation. Although premiums look attractive as they can be paid ‘pre-tax,’ consideration needs to be given to the added complexities of life insurance claim payouts and taxation under superannuation.

Have questions about life insurance in superannuation or how it can be taxed or are you about to receive a claim and want to receive some help? Start your journey to becoming your own MoneyGeek and start a conversation below.

About the Author – Benjamin Irons

Benjamin Irons

Benjamin has been involved in the financial services industry since 2004. Benjamin has a Bachelor in Business, Diploma of Financial Services (Financial Planning). Previously a Financial Adviser and a business owner, Benjamin has worked with hundreds of individuals and businesses to implement simple strategies to improve wealth. Benjamin writes for a number of websites to assist people take control of their finances and find their financial freedom!

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6 thoughts on “Taxation of Life Insurance in Superannuation

    Glenn Reply

    My son passed away aged 28 he never married had any children or was in a de facto relationship!
    He had no will and died intestate. He had very little or no assets accept for $6000 in his super and $500.000 life insurance in the super fund.
    His mother and I divorced 10 years ago. Over the last 3-4 years he lived with me and suffered mental health issues.
    The super fund wanted me to apply for a letter of administration. I advised them as myself and his mother were his next of kin and he had no assets ,we were his sole beneficiaries. I sent a statutory declaration explaining that my son and I were in a interdependency relationship and received a preliminary decision they would pay 50% to myself and 50% to my ex wife.
    They have given me 28 days to object stating the grounds on which I would be eligible to object would be I was in a interdependence relationship.
    Any suggestions on how I should respond as it seems I would be up for quite a considerable tax on the payout if I lose!
    If they did agree that we were in a interdependency relationship would I be entitled to the lot or still 50-50? Thanks. Glenn

    • The Money Geek Reply

      Hi Glenn,

      I am sorry to hear of your loss. You mention he had little assets, however with a potential $560,000 payable from his superannuation fund, this is a larger amount and your best bet is to seek legal advice to determine your position and some specific taxation advice on what liability may arise from any payout you receive. Best of luck.

    Alex Green Reply

    I am looking to open a couple of super accounts to be able to get default life insurance coverage and default income protection coverage from the 2 different super accounts (different insurers as well). It’s cheaper and requires to health declaration. My questions are:

    1/ Life Insurance: If I have say 400K with one super & 600K life insurance in another (different underwriters) then am I covered for a total of $1m? In other words are these policies independent or will the both insurers decide to pay a total of either 600k or 400k only?

    2/ Income Protection: If I have say 5K pm cover with one super & 5K pm in another (different underwriters) then am I covered for a total of $10k per month of income protection (subject to 85% of total wages etc. etc.)? In other words are these policies independent or will the both insurers decide to pay a total of either 5k per month only?

    • The Money Geek Reply

      Hi Alex,

      You need to read the T’s and C’s for the superannuation funds. Starting with the income protection, typically insurers place an ‘offset clause’ to prevent people making a claim and all of a sudden earning 150% of their employed earnings – the total limit typically payable from income protection policies is 75% of income. The same does not apply for lump sum insurance coverage, where by multiple policies typically do not offset each other. Insurers will ‘financially underwrite’ an applicant. This means if a person is insuring more than what would be typically for income and age, they will want to know why.

      Be aware one of the biggest pitfalls with default insurance cover under superannuation – it’s cheaper for a reason. If an insurer doesn’t want to know your medical history, they probably don’t want to pay against it either! Make sure you read the exclusions of the default coverage and what is actually covered. If it is one that excludes claims against prior illness or injuries for a period of time or indefinitely; it could be difficult to claim later (an issue you won’t have to deal with, but your family).

    Melinda Conn Reply

    Hi my husband recently passed away will I be required to pay tax on his super and death benefit from his super fund? I’ve lodged all the forms necessary but yet to hear anything and the super funds can’t tell me if I will be taxed. We both worked full time but had joint finances?

    • The Money Geek Reply

      Hi Melinda,

      My sincerest condolences on your loss. Given you were married, it is likely you will be deemed a ‘financial dependant’ regardless of you both working full time. Being a financial dependant means that it is likely that tax will not be payable, however this may be dependant on the components within the fund (Tax Free and Taxable).

      It is always a good idea to obtain financial advice prior to the payment being made to get an idea on what to expect from the payment and what options you have.

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