SMSF trustees beware of purchasing buy/sell insurance via your fund

IN an attempt to secure tax deductions on their buy/sell insurance policies, there is growing temptation by business owners to purchase these policies using their self-managed super funds.

However, director SMSF Consulting & Auditing, Partners Superannuation Services, Martin Murden, cautions strongly against this, saying the problems with this course of action far outstrip the benefits should the fund member die or become disabled prior to retirement.

Partners Superannuation Services is part of the Partners Wealth Group.

Buy/sell insurance in its simplest form, enables business owners in partnership, companies or businesses trading through a unit trust to purchase life insurance policies on the lives of each co-partner or owner. In the event of one of them dying, the other would be paid a lump sum benefit which would then be paid to the deceased’s surviving family members as payment for their interest in the business.

Says Mr Murden: “Not only does the family of the deceased benefit from this agreement but it also gets round the problem of the remaining partner or partners having to scurry around trying to source finance during what is an enormously stressful time.”

Buy/sell insurance can also be used to fund a buyout when a business partner becomes permanently disabled or has a serious medical trauma which would impact on their ability to continue working.

“Generally this form of insurance is purchased via an agreement between the business partners and is held personally by each co-owner. However, the Partners Wealth Group insurance division is receiving a growing number of inquiries from business owners about making use of their SMSF funds to purchase the insurance – the key impetus being the fact that a superannuation fund can claim a tax deduction on members’ insurance premiums.”

Mr Murden strongly advises against this course of action.

The problems

Failure of sole purpose test. If as part of the agreement between the business partners, there is a requirement for the insurance policy to be held by each partner’s SMSF and that the proceeds arising from an insurance claim are to be used as payment for the deceased’s interest in the business, the SMSF could be considered to have “failed” the sole purpose test under SIS, leading to an increase in the fund’s tax rate from 15 per cent to 49 per cent.

Appearance of zero-gain. If the buy/sell agreement between the parties does not specifically state the insurance proceeds in the SMSF be used as funding to allow the agreement to be completed, there could be difficulties forcing the beneficiary to hand over the interest in the business for what would appear to be nothing. If the fund has already paid the insurance proceeds to the deceased’s spouse/partner as part of the death benefit, why would they transfer an interest in the business for what appears to be no payment?

Less for investment. The insurance premiums will be deducted from contributions made to the SMSF, and because there are restrictions imposed on the amounts that can be contributed, this will reduce the amount available for investment which in turn will lead to lower retirement benefits for members.

Additional tax. If the beneficiary is not a tax dependant (adult children for example), additional tax is payable on the insurance portion of the death benefit. When a lump sum benefit is paid to a non tax dependant, tax is payable at the rate of 17 per cent (including the Medicare levy). Any insurance component of such a benefit is taxed at 32 per cent.

Mr Murden strongly recommends that when a buy/sell arrangement is in place, business owners hold total and permanent disablement insurance cover personally. He also recommends the small tax deduction (super funds are taxed at the rate of 15 per cent) be ignored and that the focus be on having the appropriate insurance cover and a buy/sell agreement in place.

“Seek advice from a specialist risk writer and have them work with a solicitor to ensure you are adequately insured and the buy/sell agreement meets your needs,” he urges.