We all know that super funds can claim a tax deduction for life insurance premiums. Far fewer know that there is an alternative that, if applicable, is worth vastly more. It is called the future service benefit deduction, and although every super fund is entitled to claim it, in practice it is used only by SMSFs. If life cover is held in a large fund and retirement savings in an SMSF, a relatively common scenario for APRA fund members who roll their savings over to an SMSF, a potential six-figure tax benefit is being lost.
When a super fund pays out a benefit because a member has died, become totally and permanently disabled, or been diagnosed with a terminal illness, the tax law can offer the fund a choice. Instead of deducting the insurance premiums it has paid, the fund can claim a one-off deduction based on the working years the member would have had if the event had not cut their career short.
The deduction is calculated on the whole benefit paid — the member’s accumulated savings plus the insurance proceeds — multiplied by the proportion of the member’s working life that was still ahead of them. For a member in their forties, that proportion is typically around half. On a substantial benefit, the deduction routinely runs into the hundreds of thousands of dollars. The resulting income tax loss can be carried forward and shelter the fund’s income — contributions and earnings for all fund members — for years afterwards.
The choice to use the future service benefit method is a once-and-forever election. A fund that makes it can never go back to deducting insurance premiums, for any member in any later year which is why a large fund with hundreds of thousands of insured members will never apply this method for premium deductions. This is generally not a concern for an SMSF.
Members who establish an SMSF but retain their previous APRA fund to keep their insurance cover may do so because they are otherwise uninsurable or because retail insurance premiums might be much more expensive. That’s fine, replacing it with cover in their SMSF is not always practical but for many it is.
Now consider what happens on a claim. For a 45-year-old member with $1,000,000 of life cover held in a large fund and $500,000 of superannuation savings in their SMSF. On death, the benefit passes to their spouse. On death, the payout is $1,500,000 across the two funds.
If the life cover is held in the SMSF as well, the benefit is still $1,500,000 but the fund could be eligible to receive a tax deduction of around $700,000 which, at a fund tax rate of 15 per cent on accumulation account earnings and deductible contributions, is worth up to $105,000 in tax savings for continuing members over the years.
Eligibility for a future service deduction is not automatic. The triggering event must have caused a cessation of employment, and a premium must have been paid in the same year in which the life cover was paid out. If the first condition is satisfied, the risk of not satisfying the second can be reduced by paying premiums monthly, not annually. So, at the time of payout, the fund may not be eligible but, if the cover is not in the fund, it will never be eligible.
Importantly, holding life insurance in a super fund of any type will create an untaxed element if benefits are not paid to a tax dependent. We will cover this next week.
Our Alliance Partners have access to Future Service information handouts to share with their trustee clients as well as a calculator that produces a report that might be included in a statement of advice.
On related note, if you are interested in transferring your SMSF administration to ourselves we have a transferring fee arrangement you might find of interest. I’m always happy to have a chat about what we can do for you. Feel free to call.
