Income protection insurance can provide a safeguard in the event you become sick or injured and unable to work, leaving you unable to make your usual SMSF contributions.
Knowing the ins and outs of SMSF income protection insurance can help guide your decision on whether it’s worth it for you. Besides, it is optional - so it’s important to know your options.
What is SMSF income protection insurance?
Most industry and retail super funds offer default income protection insurance for their customers. But with an SMSF, you’ll need to source and set up an income protection insurance plan yourself, to be held either inside or outside your SMSF.
Income protection insurance pays up to 85% of your pre-tax income in the event you're unable to work due to illness or injury. According to Moneysmart, its purpose is to replace the money you’d be earning from working, and it is calculated based on annual earnings in the 12 months prior to illness or injury.
Essentially, it means you’ll receive a large portion of money you would get from working your usual nine-to-five, even if you’re spending that time out of action. This saves you from needing to stress about finding money to cover bills, other expenses, or even just putting food on the table.
It’s a handy layer of protection, particularly if you’re self-employed, have family members or other dependents reliant on you, or have debts you’d need to cover if you were ever unable to work.
Why bother with insurance?
Off the back of the Super System Review by the Federal Government in 2015, which found that SMSF members were more likely to hold insurance outside of their super, SMSFs aren’t required to provide a default level of insurance for its members. However, the ATO does require SMSFs to note in the investment strategy that insurance protection for each member has at least been considered.
Considerations of what represents an ‘appropriate’ level of insurance could include:
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How much debt members have
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Whether they have any dependents and, if so, how they would be taken care of if they were out of work for any reason
Other types of insurance that can be provided inside an SMSF include life insurance and total permanent disability insurance. Again, public super funds typically offer a default level of these types of insurance policies to its members, but SMSF members must set up this insurance themselves.
Briefly, life cover, also known as death cover, pays a lump sum or income stream to selected beneficiaries when you die or become terminally ill. Total permanent disability insurance pays a benefit if you become seriously disabled and unable to work again.
Pros and cons of income protection insurance inside your SMSF
When deciding whether to hold income protection insurance, you’re faced with two main options: holding it inside your SMSF, or outside your SMSF. Essentially, whether the SMSF pays for it or you pay for it yourself. There are a few pros and cons to having income protection insurance inside an SMSF, which might help guide your decision on which option suits you.
Pros
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Tax-deductible
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You’re not out-of-pocket as the members' contributions pay for the insurance
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Members might have more cash flow as they don’t need to pay insurance
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Specific customisations can be made to the insurance plan (which often isn’t possible with large super funds)
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Easy application process
Cons
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Might be more expensive because of smaller fund size
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Need medical underwriting for members (not necessary with large super funds)
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Claims process can take longer due to trustee compliance requirements
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Benefit payments to non-dependents typically taxable
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Benefits can only be paid for period of incapacity (which isn’t the case if held outside a super fund)
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Retirement savings depleted because of insurance costs
Is there a tax advantage to holding income protection insurance inside your SMSF?
Income protection insurance is tax-deductible when held inside or outside of an SMSF, so this isn’t a point of difference between the two options. You might actually be at more of a disadvantage holding income protection insurance inside your SMSF, because the cap on tax deductions is reduced. Inside a super fund, tax deductions are limited to 15%, but it’s up to 45% holding it outside a super fund.
The ATO treats income protection as a replacement for normal income, so the benefit payments are treated just like assessable income (which is taxable). This means that income protection premiums are tax-deductible expenses, and any benefit payments received are not.
Income protection insurance outside your SMSF
You might be wondering whether there are any notable advantages and disadvantages to holding income protection insurance outside your SMSF, and the answer is: it depends. While this is super vague, opting for income protection, inside or outside your super, is highly dependent on your individual circumstances.
It might be a better option to hold a standalone policy if you’re looking for a higher coverage amount or more benefits and features not offered in an SMSF premium (like coverage for cancer, crises, specific injuries, etc.). But if you’re just looking for a basic backbone in the case of temporary work absence, you might be better suited to coverage inside your SMSF.
How to get income protection insurance
You can purchase an income protection insurance premium through an insurance broker, a financial adviser, or an insurance company.
When you apply, you’ll likely be asked to provide some information to help guide their decision about whether they will insure you, how much your premium will be, plus any terms and conditions in your policy. Information for you to provide could include:
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Your age
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Your job
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Your income (salary, wage, any commissions, etc.)
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Medical history
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Lifestyle choices (e.g. whether you smoke)
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Any high-risk hobbies or activities (e.g. skydiving)
What trustees should know about getting income protection insurance
When you become a member of an SMSF, you agree to meet certain obligations to fulfil the funds' primary goal: to generate wealth for the retirement benefit of the funds' members. Again, while SMSFs aren’t required to provide basic coverage to its members, it’s encouraged to consider the insurance needs of its members. Though insurance doesn’t need to be held inside the fund, SMSF members need to be adequately insured.
So whether an SMSF trustee chooses to take out income insurance protection, life insurance, or any another insurance premium, the decision of whether to hold it inside or outside the SMSF will depend on the benefits and drawbacks of doing so. Basically, if the cons outweigh the pros for the majority, insurance might be better off being held personally, rather than inside the fund. The choice depends on what’s most financially beneficial for all the fund members.
Image by Michael Longmire on Unsplash
Brooke Cooper
Rachel Horan
