Many SMSF trustees pay for life insurance for fund members. In deciding how much life insurance is needed for a member, it is important to think about the tax consequences that will apply to the benefit.
In some circumstances the trustees may hold a policy over the lives of the members where it is not linked to a specific member account. In that case, the premium is not usually tax deductible.
Insurance is held like this if the trustees intend to make a lump sum “anti-detriment” payment (“ADP”) which is designed to increase the member’s death benefit by the amount of tax paid on contributions. Trustees need to think carefully about whether they will make ADPs and the impact of an ADP on the remaining members of the fund.
The ADP is calculated based on either the actual tax that has been paid on contributions (if that can be calculated) or – more commonly – a formula set out by the tax office. It may be funded from reserves or from the insurance policy. If it is funded from reserves it will be counted against the member’s concessional contribution cap for excess contribution tax purposes.
The ADP will create a tax deduction against future earnings of the fund. Note that the deduction will be applied firstly against exempt pension income of the remaining members and this can reduce its tax effectiveness.
Usually the insurance is linked to a specific member and a tax-deductible premium is paid out of the member’s account. When the member dies, the insurance company pays the sum insured to the trustees of the SMSF and this forms part of the member’s benefit in the fund.
How the benefit is taxed depends on who it is paid to. If it is paid to dependants, either as a lump sum or as a pension, no tax is applicable. If it is paid to the estate for distribution in accordance with a will, no tax applies to benefits paid to a dependant from the estate.
If it is paid to a non-dependant, the total benefit is proportioned according to the tax-free and taxable components of the member’s account. The tax-free portion is paid to the non-dependant beneficiary tax free. The taxable component is subject to tax at 16.5%.
It is important to ensure that the trust deed, the will and any binding death benefit nominations are carefully aligned to avoid any conflicts and ensure that benefits paid are tax-effective.
Addison Partners has a dedicated team that concentrates on Superannuation lead by superannuation specialist, Jane Thomson. Addison Partners provide advice on developing and implementing superannuation strategies to reduce your tax and increase your savings for retirement. To arrange for a review, please contact your usual Addison Partners contact or call 02 4995 7300 to arrange an appointment.
Australian Taxation Office – Paying Benefits from a Self Managed Super fund – www.ato.gov.au
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