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Strategy

Financial Needs

Insurance Funding

Retirement Funding

 

One Page Strategy:

One Page Strategy

Asset Needs

Liability Needs

Personal Needs

Who Pays the Premiums?

Valuing the Business

Simplifying the Valuation Issue

Equity vs. Loan Capital

 

One Policy Strategy:

One Policy Strategy

Flexibility

Dual Role of Personal Cover

Dual Role of Debt Red'n Cover

Security & Tax-Effectiveness

Cost Savings

Pre-Agreed Purchase Price

Apportionment of Premiums

Methods of Aggregation

 

Multiple Policy Approach:

Multiple Policy Approach

Super Fund Ownership

Tax Disadvantages

Cost Disadvantages

Other Disadvantages

Geared Premium Funding

Super Buy/Sell

 

One Page, Two Policy Strategy:

One Page, Two Policy Strategy

 

Other Issues:

Tax Deductibility

Inadequate Insurance Proceeds

Vendor Finance

Changing Needs

Future Growth of Equity

Trauma Buy/Sell Strategy

 

Sole Proprietors and Families:

Sole Proprietors and Families

Overview

Family Ownership

Sale Strategies

Third Party Buy/Sell Strategies

Estate Equalisation Strategies

Family Buy/Sell Strategies

Second Generation Strategies

Debt Reduction Strategies

 

 

Other Disadvantages of Super Fund Ownership

 

This page focuses on the commercial, personal, family and other implications and disadvantages with respect to Super Fund Ownership of Insurance Cover.

Overview of Super Fund Ownership

Click here for an overview with respect to Super Fund Ownership.

Tax Issues

Click here for an analysis of some of the Tax Issues with respect to Insurance Cover held in the Superannuation environment.

Cost Issues

Click here for an analysis of some of the cost implications and disadvantages with respect to Super Fund Ownership of Insurance Cover.

 

Restricting Distributions to Dependants

Click here to read about the potential tax liability with respect to Super Death Benefits paid to Non-Dependants.

The tax liability could be avoided by restricting the distribution of the Death Benefit exclusively to Dependants.

This complicates the distribution of assets of the Estate between Dependant and Non-Dependant Beneficiaries.

Effect on Will Strategies

If the intention was to treat Dependant and Non-Dependant Beneficiaries of the Estate equitably, it would be necessary to differentiate between the Beneficiaries in the Will, in order to compensate the Non-Dependants for any lack of access to the Insurance Proceeds (an "Estate Equalisation strategy").

For example, it might be necessary to gift the Life Insured's home (or another asset held outside Super) to a Non-Dependant in order to equalise the distribution of assets.

Effect on Testamentary Trust Strategies

These strategies can compromise the tax benefit obtained from a Testamentary Trust in the Life Insured's Will.

A Testamentary Trust is designed to avoid the payment of the whole of the Estate to one Beneficiary (such as the Spouse), which would result in all income from the investment of the Insurance Proceeds being taxed at the Spouse's marginal rates.

A Testamentary Trust allows distributions to multiple Beneficiaries, which can achieve lower tax rates with respect to the total income of the Testamentary Trust.

More Sophisticated Will Strategies Required

Subject to the use of an equalisation strategy, the tax liability with respect to distributions to Non-Dependants might make it necessary to:

  • restrict the Testamentary Trust to assets other than Insurance Proceeds;

  • restrict the Testamentary Trust to Beneficiaries who are Dependants; or

  • gift the Insurance Proceeds exclusively to the Spouse if there are no Dependant children (which would result in all income from the investment of the Insurance Proceeds being taxed at the Spouse's marginal rates).

These issues and strategies obviously involve more sophisticated and expensive drafting as well as regular updates (e.g., "codicils" to the original Will) to reflect any changes in the composition and value of the Estate.

 

Super Fund Trustee's Discretion

The Trustee of the Super Fund has a discretion with respect to the distribution of the Member's Benefit (including the Insurance Proceeds).

If it considered that a potential Beneficiary was entitled to a payment on the basis of need or equity, it would be entitled to distribute a Benefit to the Beneficiary (regardless of the tax liability).

The Member can restrict the Trustee's discretion by signing a binding Nomination that identifies the Beneficiaries to whom the Benefit may be paid.

If this option is used to avoid distributions to Non-Dependant Beneficiaries, it is important that the Nominations are renewed and updated.

The differential treatment of children would need to be addressed through the Life Insured's Will, if the intention was to treat children equitably.

 

Access to TPD and Terminal Illness Benefits

The payment of the Insurance Proceeds to the Super Fund in the case of disability does not necessarily mean that a Condition of Release has been satisfied and the Insurance Proceeds can be distributed to the Member.

This is a major risk if the Benefit is:

  • an "Own Occupation" TPD Benefit; or

  • a Terminal Illness Benefit.

 

Trauma Benefits

There have always been questions as to whether it is appropriate to hold Trauma Cover in Super.

The two main reasons have been:

  • the failure to expressly mention the deductibility of the Premium for a Trauma Benefit.

  • the question whether it is a breach of the Sole Purpose test, if the Insurance Proceeds aren't able to be distributed to the Member upon the occurrence of an Insured Event.

Deductibility

The deductibility issue is likely to need legislative action to clarify the position.

Sole Purpose Test

However, it seems that the ATO is moving towards acceptance of Trauma Cover in Super from a Sole Purpose test point of view.

On 4 November, 2009, the ATO issued SMSFD 2009/D1.

In summary, the Draft Ruling states as follows:

  1. A trustee can still satisfy the sole purpose test provided any benefits payable under the policy: ·

    • 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.

  2. However, if a trustee purchases a trauma insurance policy that provides for benefits payable under the policy to be paid directly to someone other than a trustee of the SMSF (for example, the insured member or member's relative is the beneficiary of the policy) this would be inconsistent with the sole purpose test in section 62 of the Superannuation Industry (Supervision) Act 1993 (SISA).2 In these circumstances the trustee would contravene section 62.

This places Trauma Benefits in a similar position to Own Occupation TPD Benefits.

Practical Implications

The possible inability to distribute the Insurance Proceeds to the Member questions the commercial purpose of including them in the Super environment.

If they do not satisfy a Condition of Release, they cannot be released to satisfy a financial need of the Member, such as the need to:

  • fund medical treatment;

  • fund Living Expenses; or

  • reduce Personal Debts and Liabilities (so that the lack of income does not cause a default under a Loan Agreement or Security).

Relationship with Income Protection Strategy

The Life Insured's Trauma Strategy needs to be carefully coordinated with their Income Protection Strategy.

The Trauma Cover can address lump sum needs, while the Income Protection Cover can address recurring needs.

It is possible that some of the recurring needs could be met by the Income Protection Benefit, assuming it becomes payable.

However, if it is anticipated that access to the Trauma Benefit would still be needed by the Member to fund lump sum needs, Super Fund Ownership might not be appropriate from a practical point of view (rather than a legal or tax point of view).

Split Trauma Cover

Alternatively, the total Trauma Cover could be split between the Super and Personal environments.

This would allow some Trauma Cover to be available for immediate needs, while the rest could be held in Super and form part of an accumulation strategy after the payment of the claim (pending the satisfaction of a Condition of Release).

Geared Superannuation Investments

If the Super Fund has a geared investment, the Fund itself might take out Trauma Cover, which would allow it to reduce the Debt upon the occurrence of an Insured Event with respect to the Member.

If the Debt relates to a property which has been leased to a Business in which the Member has an interest, an alternative strategy would be for the Business to obtain Key Person Income Cover, which would allow it to continue paying the rent upon the occurence of an Insured Event.

The Premium with respect to this Cover would be deductible, without having to be held in the superannuation environment.

 

Accumulation Potential of Superannuation Fund

Members of Superannuation Funds are restricted in the amount of the Concessional (and Non-Concessional) Contributions they can make each year.

If Contributions are invested in assets, the income and capital growth of the assets is taxed concessionally.

However, if the Contributions are used to pay for Premiums with respect to Insurance that would have been tax-free, the member does not derive any benefit from the concessional tax treatment of the asset held by the Super Fund.

Indeed, as mentioned above, the tax treatment of the Insurance Proceeds is worse than the treatment of Insurance Proceeds held outside Super.

However, the diversion of some of the Contributions from the investment strategy of the Fund restricts the accumulation potential of the Fund that would otherwise occur as a result of the compound growth and concessional taxation of the assets of the Fund over time.

Post 2009 Budget Update:

The desire to obtain maximum advantage out of Concessional Contributions should be greater as a result of the reduced caps on Concessional Contributions introduced in the 2009 Budget.

The reduced caps are a limit on the accumulation potential of the Super Fund.

Subject to the investment return within the Fund, it will now be harder to achieve a targeted capital amount by the date of the Member's retirement.

Obviously, if investment returns suffer (because of events like the Global Financial Crisis), it might be necessary to increase both the total amount and the percentage of Concessional Contributions used for investment purposes.

If a Premium is paid out of Super, it will now represent a greater percentage of the Concessional Contribution that will not be available for the Fund's investment strategy.

If stepped Premiums are used, the percentage will increase over time.

Less and less of the Concessional Contribution will be available for investment.

Ironically, this will occur as the Member is getting closer to retirement age, when Investment Contributions should be increasing.

In the Personal context, this might not be a problem if the need for Personal Insurance has decreased.

However, it might be a problem if the Member:

  • requires Super Buy/Sell Insurance for their Equity in an ongoing Business; or

  • wishes (or is required) to insure ongoing Personal Investment Debt.

Implications of Henry Report

The Henry Report is due to be delivered to the Government on Christmas Eve, 2009.

It is likely that there will be recommendations that reduce the tax-effectiveness of Superannuation Contributions for Members on the highest marginal tax rate.

This could reduce the appeal of funding insurance premiums out of super, just so that the premiums can be tax-deductible.

 

Limited Availability of Deduction

From the Life Insured's point of view, the deduction for the Premium is only available if the Premium is paid out of a deductible, Concessional Contribution.

It will not be available where:

  • the Life Insured is already making the maximum Concessional Contributions to the Super Fund for investment purposes; and

  • the Premium will effectively be paid out of Non-Concessional Contributions.

This distinction will be most important for Lives Insured in their 40's, 50's and 60's who are attempting to make maximum Concessional and Non-Concessional Contributions in order to maximise their Benefits.

Thus, the effective deduction for the Premium might only be available for a limited period during the life of the Life Insured, in particular, when the Life Insured is relatively young and the Premium is relatively low (and therefore affordable).

 

Inability to Apportion Premiums Proportionately

Where the Buy/Sell Cover is held outside the Super environment, it is normally recommended that the Buy/Sell Premiums be pooled and split proportionately to each Life Insured's equity in the Business.

Thus, if the Premiums for three equal Proprietors were $1,500, $2,000 and $2,500, each Proprietor would pay $2,000.

In the case of Super Buy/Sell, each Fund will have to pay the Premium with respect to its own Member's Super Buy/Sell Policy.

Thus, it is not as straightforward to spread the cost proportionately across the Proprietors.

One option would be to make a contribution of $2,500 (i.e., the highest Premium) to each Fund.

This would equalise the cost of the strategy.

However, it would also increase the total cost to $7,500 (instead of $6,000).

Thus, the desire to equalise the cost would partly counteract the benefit of tax deductibility.

 

Loss of Single Policy Volume Discounts and Benefits

A Business Person who wishes to obtain a tax deduction for their Buy/Sell or Personal Cover must normally use a Multiple Policy Strategy.

The Single Policy Strategy is designed to obtain volume discounts with respect to the Premium for the whole of the aggregate Sum Insured.

Depending on the amount of the Sum Insured, the discounts can be between 5% and 30%.

If the aggregate is broken into two or more separate, smaller Policies, these discounts might not be available.

Comparison of Financial Benefits

Clients should compare:

  • the dollar benefit of the deductibility of the Super Premium with

  • the reduction of the dollar benefit of a volume discount with respect to 100% of the aggregate Sum Insured.

In other words, it is important to compare the dollar benefit of the deduction of the Premium for, say, 50% of the total Cover (i.e., the Super Cover) with the potential loss of the dollar benefit of the Premium Discount with respect to the Premium for 100% of the total Sum Insured.

In a sense, the Premium doesn't have to be deductible to result in a benefit for the Life Insured.

The important issue is the net cost of the premium after tax.

Underwriting Issues

If the different needs are not aggregated onto one Policy, each separate Policy needs to be reviewed and amended as needs change.

This might require underwriting, medical tests, financial evidence, administrative time and financial cost.

Again, these factors should be weighed against the apparent benefit of the tax deduction for part of the Premium.

 

Inability to Use Policy as a Security for Loans

It is common for Banks to take a security over a Policy with respect to:

  • a loan to the Business (which might be guaranteed by each of the Proprietors);

  • a Personal Loan; or

  • a Loan to the Life Insured in order to fund the original Purchase Price of their Equity in the Business (an "Equity Loan").

If the Policy is held in the Superannuation environment, it will not be available to the Bank as a security.

As a result, the Bank might require the Life Insured to take out additional cover in their own name.

The additional premium cost can defeat the benefit of the deductibility of the Premium of the Super Policy.

 

Inability to Pay Premium Out of Credit Loan Account

In many businesses, the Proprietors have lent funds to the Business to help fund working capital.

Many small businesses find it difficult to repay these "credit loan accounts".

If the Business pays a premium on behalf of the Life Insured, the premium can be set-off against the debt owing by the Business.

This will reduce the loan owing over time.

In some cases , the premium might effectively be funded out of capital of the Life Insured, rather than after-tax income (although it is arguable that the capital itself might represent previous after-tax income).

It is generally regarded as desirable to reduce credit loan accounts.

The payment of Premiums on behalf of the Life Insured is one practical method of achieving this goal.

This goal would not be achieved if the premium was paid out of a deductible contribution (i.e., income that would otherwise have been subject to income tax).

 

Future Change of Apportionment of Aggregate Sum Insured

The Single Policy Strategy allows the Life Insured to change the apportionment of the total Sum Insured as their needs change.

A Life Insured might arrange the initial cover outside the Super environment for a combination of the above reasons.

However, if they subsequently acquired a Self-Managed Superannuation Fund, they might wish to apportion some of the Benefits to the Super Fund.

If a Life Insured has a Self-Managed Super Fund, they can obtain all of the benefits of a Single Policy Strategy as well as deductibility where appropriate.

This strategy can provide benefits when the investment strategy of the Member warrants a SMSF and the Stepped Premium has become a greater burden over time.

(N.B. To the extent that it might be necessary for the SMSF to acquire an interest in a Policy owned by a Member, it might be necessary to cancel and re-issue the Policy in order to achieve this goal.)

 

Super Buy/Sell Issues

In recent years, it has become increasingly common for a Super Fund to own Buy/Sell Cover.

This practice is known as "Super Buy/Sell".

See Super Fund Ownership of Buy/Sell Cover.

 

One Page Summary of Issues

Clients should also consider the attached summary of issues with respect to Super Fund Ownership.

 

The "Geared Premium Funding" Alternative

Please see here for an alternative cash flow strategy ("Geared Premium Funding"), which is designed to overcome most (if not all) of the disadvantages of Super Fund Ownership (in particular, the potential taxation of the Insurance Proceeds in the hands of the Super Fund or the Beneficiaries).

 

Copyright: Ian Gray Solicitor

 

 

Adviser Tip

A Volume Discount on 100% of the total Sum Insured held by the Insurance Trust might be worth more than a tax deduction for 50% of the Sum Insured, even though none of the Cover held by the Insurance Trust might be held in the superannuation environment.

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See more Adviser Tips

 

 

 

Current Marketing Schedule

Current Marketing Schedule

 

Ian Gray travels to most capital cities regularly throughout the year and is available for Meetings.

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