Geared Premium Funding

Click here for an analysis of some of the commercial, personal, family and other implications and disadvantages with respect to Super Fund Ownership of Insurance Cover.

Borrowing the Premium ("Geared Premium Funding" or "Premium Loans")

Where the Premium is paid out of a Contribution to the Super Fund that was deductible (i.e., a Concessional Contribution as opposed to a Non-Concessional or Un-deducted Contribution), the Premium is indirectly deductible.

The deduction effectively allows the Premium to be paid with "pre-tax dollars" (rather than "after-tax dollars").

As mentioned on this page, there can be a number of disadvantages with respect to this strategy (including the potential taxation of the Insurance Proceeds).

The tax disadvantages can be wholly overcome (and the other disadvantages can be wholly or partially overcome) by a "Geared Premium Funding" strategy.

What is a Geared Premium Funding Strategy?

Under this strategy :

the Cover is held outside the Super environment (e.g., by the Life Insured or the Trustee of a Business Insurance Trust);
the Life Insured borrows the funds required to pay the Premium on an interest only basis (a Premium Loan);
the Life Insured still makes the Concessional Contributions that would have been allocated to the Premium payable by the Super Fund;
the whole of these Contributions are allocated to the investment or accumulation strategy inside the Super Fund; and
the Life Insured repays the principal with respect to the Premium Loan out of the Benefits of the Fund ultimately distributed to the Member (i.e.., upon a claim or retirement).

Premium Not Paid Out of "After-Tax Dollars"

Because the Life Insured borrows the Premium, it would not be paid out of "after-tax dollars".

The Life Insured would only need to fund the interest cost of the loan, pending repayment of the Principal out of the Member's benefit. (The interest could even be "capitalised" under the terms of the loan.)

The Life Insured would usually draw down the loan in annual instalments equivalent to the amount of the annual premium at the time.

Thus, over time, the Principal owing with respect to the Loan would increase, while the total interest payable each year would increase.

However, the aim of the strategy is that the accumulation, compounding and concessional tax strategy in the Super Fund will ultimately offset the interest cost of the loan (as well as enable the repayment of the Principal).

Example

If the interest cost of each annual instalment was 10% of the principal of the loan, then the average interest cost of each annual instalment would be 0.03% of the Sum Insured (i.e., 10% of 0.3% of the Sum Insured).

For example, if the Sum Insured was $1 million:

the average Premium cost would be $3,000 per annual instalment; and
the average interest cost per instalment (at 10% interest) would be $300.

Instead of cash flowing $3,000 per annum, the Proprietor would only need to fund $300 per annum per instalment of Principal.

For example, over a three year period, the Proprietor might have to fund:

$300 in the first year;
$600 in the second year;
$900 in the third year;
a total of $1,800 over the three years (instead of a total of $9,000 in premiums after tax); and
repayment of the loan of $9,000 out of the Member's benefit (i.e.., not from after-tax dollars).

Similarly, over a ten year period, the Proprietor might have to fund:

a total of $16,500 over the ten years (instead of a total of $30,000 in premiums after tax); and
repayment of the loan of $30,000 out of the Member's benefit (die., not from after-tax dollars).

Repayment of Loan From Member's Benefit

To the extent that the loan is repaid out of the Member's benefit, it would effectively be repaid out of the pre-tax Contributions or the Member's balance in the Super Fund (which ultimately derived from the accumulation and concessional tax treatment of the Super Fund).

This strategy is designed to achieve much, if not all, of the cash flow benefit that paying the Premium with "pre-tax dollars" would obtain.

Obviously, it would be desirable that the investment growth of the Fund exceed the interest cost of the Premium Loan.

However, even if it didn't (or the cost benefit of the strategy was marginal), the strategy would avoid or minimise the other disadvantages of Super Fund Ownership (including the avoidance of the income tax liability on the Death and TPD Benefits).

Need For Personal Advice

N.B. This strategy needs to be considered on an individual basis with the advice of the Client's Adviser and/or Accountant.

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.

See more Adviser Tips

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