The Power of SMSF Life Insurance

18 May 2023

Written by

David Busoli, Principal

I’ve posted this article before but it’s worth repeating as I’ve just processed a case, with over a million dollar income tax deduction, that will be carried forward and used to offset contribution tax and earnings tax for remaining members for many years.

Section 295-470 of the ITAA (Future Service Benefit) allows a Fund to claim an income tax deduction on the payment of:

1.     a superannuation death benefit; or
2.     a terminal illness benefit; or
3.     a disability superannuation benefit or
4.     a temporary incapacity income stream.

The deduction, also known as the Future Liability deduction, is available irrespective of whether the benefit is paid as a pension, lump sum or combination and can be used to offset current and future income tax liabilities.

The payment must involve a termination of a member’s employment or self employment. It is generally only available if the event occurs prior to the member’s 65th birthday.

The deduction is an alternative to taking a deduction for life insurance premiums so, to be eligible, the Fund must hold a life insurance policy on the member’s life and a premium must have been paid in the year of the event. In order to minimise the possibility that a premium is not paid in the relevant year we suggest that all premiums be paid as frequently as possible – monthly, or even fortnightly, if available.

Once a fund has claimed this deduction it can never again take a deduction for insurance premiums. It is for this reason that this deduction is only taken by SMSFs.

The size of the deduction depends on the size of the total benefit. The amount of life insurance included in the benefit payment is irrelevant with the same deduction being achieved for a given benefit irrespective of whether it was predominantly sourced from life insurance or from savings.

Caution must be exercised as, though holding an insurance policy is a prerequisite to claiming a Future Service Deduction, it will also cause an untaxed element to be created if the beneficiary of the payment is not a tax dependent. Typically, this will arise when the beneficiary is an adult, independent child.

A typical deduction generated for a fund with an eligible member is;

Retirement Age 65
Date of Birth 1-3-1975
Date of Termination of Employment 1-5-2018
Eligible Service Date 1-5-2002
Benefit Amount $1,000,000, including $50,000 in life insurance proceeds.

The future service benefit income tax deduction in this case is $577,104. At a 15% tax rate this is a real cash benefit of $86,565 in tax saved over time.

Assisting SMSF Advisers with the practical application of items such as this is what we do. Why not have a chat with us to consider how we can add value to your SMSF service proposition.

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