Previously we considered the future service benefit deduction — a benefit that makes holding life insurance inside an SMSF very attractive if the benefit is heading to the right people, but what happens if it’s not? The result is a rather nasty untaxed element that applies to large APRA funds as much as it does to SMSFs.
The right people includes the member or their tax dependants — a spouse or former spouse, a child under 18, a person who was financially dependent on the member, or a person in an interdependency relationship with them — as they can receive a death benefit entirely tax-free, whatever its components and however large it is.
The wrong people are non-tax dependants — most commonly adult, financially independent children — who pay tax on the taxable component of the benefit: 15 per cent (plus Medicare levy if paid directly from the fund) on the ordinary (taxed) element, and 30 per cent on any untaxed element.
The untaxed element is not confined to funds that claim the future service benefit deduction. It arises automatically whenever the fund has held life insurance for the member and deducted its cost, the death benefit is paid as a lump sum to a non-tax dependant, and part of the benefit relates to the member’s lost future working years.
The law then applies the future service benefit formula in reverse to provide an untaxed element with no discretion involved.
The planning direction follows directly from the rules. Where the people you intend to benefit are tax dependants — a spouse, young children — holding cover inside the fund is attractive, and the potential for the future benefit deduction makes it more so. Where the intended beneficiaries are adult independent children, life cover generally does not belong in superannuation at all: held outside super, the proceeds reach them untaxed. Existing policies can often be restructured, and benefits can be directed so that insurance-backed benefits flow to dependants while other assets flow to non-dependants — but these are decisions to make deliberately, while they can still be made.
Our Alliance Partners can access our Future Service Benefit Calculator which models both sides of the equation.
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.
