Trauma Insurance, also known as Critical Illness Insurance, has also grown in popularity as families seek lump sum coverage for major illnesses. Unlike Life Insurance in SMSF’s and to a lesser extent TPD Insurance in SMSF’s, Trauma Insurance in SMSF’s is not as common. Industry wide, it is not normally offered by retail and industry superannuation funds at all!
There are a number of issues with Trauma Insurance in SMSF’s, some resolved and some that are yet to get a definitive answer from regulators. Of most prominence, historically it has been difficult to argue that Trauma Insurance contributes to the retirement, death or disablement of a member and there have been a number of questions raised as to if Trauma Insurance in SMSF’s breach the sole purpose test. The ATO in determined in 2009 (SMSFD2009/1) that in certain conditions a trustee can take a trauma insurance policy out on behalf of its members.
The ATO in its determination stated that the following criteria need to be met
- are required to be paid to a trustee of the self-managed superannuation fund (SMSF);
- are benefits that will become part of the assets of the SMSF at least until such time as the relevant member satisfies a condition of release; and
- the acquisition of the policy is not made to secure some other benefit for another person such as a member or member’s relative.
What does this mean? Can I hold Trauma Insurance in a SMSF?
The ATO determination established that a SMSF can hold a trauma policy as long as the SMSF is held by a trustee and paid for by the SMSF. In addition, the policy must cover a member of the fund and must any claims must be paid to the SMSF until the member meets a condition of release.
UPDATE: Stronger Superannuation Reforms (Superannuation Legislation Amendment Regulation 2013 (No. 1)) have introduced a new operating standard among other changes to the SIS Regulations (4.07D Operating standard—permitted types of insurance). These changes limit the types of insurance that can be offered by an SMSF to new members from 1st July 2014 to policies where claim definitions are aligned strictly with conditions of release. It is unlikely that Trauma Insurance or Own Occupation TPD Insurance will be permissible from that date. Advice is strongly recommended in determining your insurance needs.
Why would I hold Trauma Insurance in a SMSF?
Trauma Insurance in a SMSF isn’t a strategy that is recommended for everyone, in fact there are a number of reasons not to recommend this method of owning and paying for a Trauma Insurance policy however there are a number of areas where it can be appropriate;
- Contributions Caps – the federal government has reduced the concessions contributions cap to $25,000 p.a. at least until 2014. Legislation to increase contributions cap’s is yet to be introduced. The reduction from $50,000 for over 50’s limits the ability for individuals to build superannuation in preparation for retirement. With around a 1 in 3 chance of a Trauma event occurring prior to age 65 1, a potential Trauma Insurance in an SMSF strategy is to use a policy to ‘insure future contributions’ by taking a policy out to pay in this event to both boost the ‘contribution’ above the caps (claims payouts do not count towards contributions caps) and to have additional funds on early retirement.
- Bankruptcy – Superannuation assets are generally not included in bankruptcy claims. It is not uncommon for a critical illness to be the major contributor to business insolvency. Trauma Insurance policy within a SMSF can be a method of planning so that for the self-employed, a superannuation balance boosted by a critical illness policy claim provides an income in retirement.
- Premiums – Trauma Insurance when held by an individual is generally not tax deductible. When a policy is held within superannuation, premiums can be funded by tax deductible contributions for the self employed and pre-tax contributions for employees. This essentially makes the premiums more tax efficient to the individual.
Why wouldn’t I own Trauma Insurance in a SMSF?
Notwithstanding the points above, there are a number of reasons where holding Trauma Insurance in a SMSF can be more trouble than it is worth.
- Tax – Tax plays a major part in trauma insurance policies in a SMSF. Unlike Life Insurance and ‘any occupation’ TPD Insurance; Trauma Insurance premiums are not tax deductible to the SMSF. This can cause some accounting issues within the SMSF and for members without good accounting support can cause administrative problems. In addition to the premiums not being tax deductible; where Trauma Insurance policies form a ‘disability benefit’ from a SMSF, claims payments incur a taxation liability, similar to TPD insurance claims in superannuation. The taxation payable combined with the non-tax deductibility of premiums can make trauma insurance in a SMSF quite unattractive and an individual’s circumstances need to be carefully considered.
- Premiums and Cash flow – Where insurance premiums take up a sizable portion of the contributions being made to the fund or the overall contributions cap, scrutiny can be directed to the fund as the primary purpose of the fund, saving for retirement may not be fulfilled. This is also compounded by investable dollars being diverted to insurance premiums resulting in a diminished balance being available for retirement. Questions are yet to be answered as to if Trauma Insurance is taken in a SMSF for the purpose of improving a member’s cash flow, if this in breach of the ATO’s third requirement as an improvement to cash flow can be considered ‘securing another benefit.’
- Condition of Release – In order for trauma insurance claims to be paid from a SMSF, a condition of release needs to be met, most trauma insurance claim events do not initially result in a member meeting the ‘any occupation’ definition of total and permanent disablement (TPD) and as such benefits can be held within the fund. If the TPD definition is not met, then the member would need to wait until a different condition of release is met, normally retirement. This can result ongoing financial distress which can defeat the purpose of coverage.
There are a number of challenges and considerations that trustees of self-managed superannuation funds need to reflect on before deciding if it is appropriate to hold trauma insurance in a SMSF. Advice is paramount as trauma insurance is arguably the most complex policy to hold in a SMSF.
Issues and considerations aside with using a SMSF to hold Trauma Insurance, there are a number of products and strategies available to hold Trauma Insurance in a cost effective manner, incorporating Life and TPD insurance within superannuation without some of the disadvantages of having Trauma Insurance held within a SMSF.
Have a question around Trauma Insurance in your SMSF or superannuation generally? Start a conversation in the comment section below!
1 ABS – Year Book Australia 2002 – Health – Special Article – Chronic diseases and risk factors
About the Author – 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!