The federal budget proposals to make insurance ‘opt-in’ for super members under 25 who have low balances or inactive accounts make it essential for SMSF trustees and advisers to review these clients’ insurance cover.
“A ‘set and forget’ approach is no longer relevant. The budget proposals for opt-in insurance will have a number of unintended consequences and not just for members with small balances,” explains Natasha Panagis, AIA Australia’s technical manager. “If a member has an inactive account in a fund to keep insurance cover they will be affected. Older clients with money in an [Australian Prudential Regulation Authority] APRA-regulated fund will also be affected, it’s not just those aged under 25.”
Speaking to Professional Planner about her upcoming appearance at the SMSF Association Technical Roadshow, Panagis says clients need to take action prior to July 1, 2019, if they do not want to lose existing insurance cover.
“They need to opt-in, make additional contributions or redirect employer contributions back to their APRA-regulated fund prior to this date,” she explains.
KPMG predicts the opt-in proposal will lead to increases in insurance premiums across the industry and SMSF trustees and advisers need to revisit their insurance needs.
“Group life insurance premiums are forecast to increase 26 per cent for remaining insured members,” Panagis warns. “Advisers are likely to find group insurance premiums will become more costly within super, so they may need to consider other options for clients.
“The idea behind the proposals is to stop erosion of members’ account balances, but if it leads to more expensive premiums, members will be financially worse off, as it may erode balances even more.”
Death benefit pension strategies also need to be reassessed, particularly in light of the 2017 super reforms; for example, advisers need to review the impact of the transfer balance cap of $1.6 million. A death benefit including insurance will probably exceed that, particularly as the payout is assessed differently depending on whether the pension was discretionary (non-reversionary) or reversionary.
Pension type is important because an automatic reversionary death benefit pension does not count towards the beneficiary’s transfer balance account until 12 months after the deceased’s death, Panagis explains.
“What counts is the value of the deceased’s pension at the date of death. Insurance benefits are not included, as they are not paid immediately and, therefore, do not form part of the deceased’s pension balance at the date of death,” she says.
This is a rare chance for reversionary pension clients to have more than $1.6 million in their pension phase account, she explains. “It is also a niche opportunity for SMSFs – it cannot be done in a public offer fund – and it can be very helpful when pension-phase clients need life insurance to cover off any household debts they may have.”
Panagis urges advisers to revisit whether clients should hold insurance inside or outside super and the best type of fund for their situation.
“There are different pros and cons, depending on whether the client is in an SMSF, an insurance-only super fund or a public offer or retail fund.”
Key benefits from holding cover through an insurance-only super fund include lower upfront premiums and ownership of the cover.
“If the premiums are paid from a roll-over, generally the client receives a 15 per cent upfront discount,” Panagis says. Downsides involve maintaining an additional super account and death benefits being paid as a lump sum due to product limitations.
Holding insurance through an SMSF, on the other hand, allows more tailored cover and provides greater estate-planning benefits.
“Although an SMSF can claim a deduction for the premium against other assessable income of the fund, the fund will generally pass the 15 per cent tax saving to the member’s account later on in the financial year,” Panagis explains. “So when deciding to purchase insurance via an insurance-only product or SMSF, clients should not be swayed by the 15 per cent upfront rebate. Advisers need to weigh up the benefits of each strategy.”
The regulator’s views on insurance in super also need to be considered when giving life insurance advice.
“Advisers need to ensure clients understand the policy is owned by the fund trustee, the tax implications on payout and estate-planning issues, and that premiums may erode their retirement savings,” Panagis says. “It is not enough to inform clients of these risks. Advisers need to address issues such as ways to negate balance erosion and provide options to mitigate the risk, such as making further contributions or the potential need to work longer.”