By Liam Shorte 8 Apr 2015

Insurance primer: Income protection (Part 2)

Should you take out income protection in super, your own name, or both? Liam Shorte and Richard Livingston explain the issues and strategies.

Snapshot

  • No extra tax benefit in taking out IP through super
  • Super rules limit the benefits of policies taken out in super
  • IP in your own name is generally the best approach, but there is an alternative

In Insurance primer: Income protection (Part 1) we explained the features and traps to look out for in an income protection (IP) policy. Another key consideration is whether you should take out the policy through your super or in your own name?

Let’s take a look.  

Inside or outside of super?

The main point to note is that there’s no extra tax benefit in taking out IP through super. Unlike other forms of insurance (for example, life cover) IP premiums are generally tax deductible to individuals. In the event of a claim, you’ll also be taxed at your marginal rate on the benefits whether the policy is inside or outside of super.

Lack of tax benefits aside, there can also be some disadvantages to taking IP through super. If you’re trying to maximise your super, the IP premium is effectively reducing your contributions. This can become a real problem as you age and premiums rise.

IP in super is also a problem if you are partially disabled or earning a part-time income during a period of illness or disability.

If your IP policy is held through super, you won’t be able to receive a benefit in as many circumstances as you would outside of super. This is because an IP policy inside super can only pay a benefit if a ‘condition of release’ (as set out in the SIS RegulationsThe Superannuation Industry (Supervision) Regulations. These contain additional rules that support and expand on the rules contained in the SIS Act.) is met (although note that these rules changed 1 July 2014 so our comments may not apply to policies taken out before that date).

These conditions of release in the SIS RegulationsThe Superannuation Industry (Supervision) Regulations. These contain additional rules that support and expand on the rules contained in the SIS Act. are more onerous than the requirements of the good IP policies (outside of super). For instance, they state that ‘temporary incapacity’ is where you’ve ceased gainful employment.

This can be problematic if you have the ability to do some work, move to a different job, carry out limited tasks due to partial disability or if you were in between jobs when you were incapacitated. Under a super policy you won’t be able to use the hours-based definition of disability (which lets you work up to 10 hours per week without affecting your benefit) and you won’t be able to get ‘own occupation’ cover (however, please see our comments below about ‘linked cover’).

In situations where you receive sick leave benefits from your employer, your benefits from a super policy will be reduced, whereas many IP policies outside of super are not offset by sick pay.  Often, where there is a waiting period, the sick leave has been exhausted before benefit payments commence.

The other thing ‘missing’ from super-based policies are 'agreed value' or 'guaranteed value' contracts – important for those whose earnings may vary from year to year – and ancillary benefits such as childcare or needle stick injury. These can’t be offered by a super fund as there’s a risk the ‘sole purpose testThe 'sole purpose test' is contained in section 62 of the SIS Act. The object of the test is to ensure that the super fund is being run for the sole purpose of providing retirement benefits to members (plus ancillary payments like death benefits). Common breaches of the sole purpose test are members of a fund (or their relatives) using property of the fund (for instance hanging art belonging to the fund in their home) or borrowing money from the fund. More information can be found on the ATO website.’ will be breached. 

For all these reasons, we generally suggest taking out an IP policy in your own name.

But there are some situations where you might consider taking out IP through super, including:

  • If you’re struggling with cash flow, taking out IP through super effectively enables you to access your compulsory super contributions to pay the premiums.
  • For industry and employer funds, premiums can sometimes be more competitive as you become part of a group risk. In these cases, you’ll need to weigh up the benefit of lower premiums against the disadvantages of IP cover through super. Note however, with the increased claims experience suffered by these funds in recent years, not everyone will benefit from being part of a group risk. Those with favourable circumstances might get cheaper premiums by going direct. 
  • ‘Automatic acceptance limits’ have increased for employer-sponsored plans. This potentially makes it easier to get cover through your employer super, especially where personal health issues might make it difficult to get cover directly.
  • If you’re a low-income earner (assuming you’re not fully utilising your concessional contributions capThe annual cap (for each year ended 30 June) on the amount of concessional (pre-tax or tax deductible) contributions a person is allowed to contribute to super. For more information on cap amounts see the ATO website.), funding IP premiums by making extra super contributions may allow you to get the Government co-contribution. But you need to be careful that, down the track, you’re not going to run into one of the problems we identified above.

If you’re in an employer-sponsored plan that offers basic IP cover, it may be enough for your purposes. In this case, it might be simpler to stick with what you’ve got rather than go through the process of setting up an IP policy outside of super.

Your other option, if cash-flow is tight but you want better cover than you can get through super, is to consider a ‘super link policy’ (different companies use slightly different terms). Under this approach, the main cover is written and paid for inside super with a ‘linked’ partial policy outside super covering things like ‘own occupation’ and ancillary benefits.

In the event of a claim, the assessors will seek to pay the benefit under the super rules. But if they can’t, they turn to the cover outside super and pay you directly under that policy (assuming you’re entitled to it).

If you have limited cover through your industry or employer fund, you can also consider backing that up with a non-super policy with a two year waiting period. This would cover you for worst case scenarios but at a competitive premium. People can often manage on their basic cover for two years, but if it is a long-term injury or illness, savings can deplete quickly and so a second policy kicking in after two years can be very helpful.

A policy inside super or a linked policy can work for some, but for most people insuring outside super is the way to go. Just remember our warning from Part 1 to stick with the established insurers and avoid the low-cost policies, unless you have a very good understanding of their exclusions and limitations, and are confident you’ll be able to make a successful claim if the time comes.

 

Liam Shorte is a principal of Verante Financial Planning Pty Ltd (www.verante.com.au), a corporate authorised representative of Magnitude Group Pty Ltd (AFSL 221557). This article is a general information article and to the extent it contains any financial advice it is general advice only. We recommend seeking personal advice on your own circumstances.

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