Funding insurance in super with rollovers
Overview of opportunity
When a person joins a non-retail super fund, such as an industry, public sector or corporate fund, they may qualify automatically for certain insurances where no health evidence or disclosures are required.
But the fixed or formula based amount of cover provided by non-retail funds rarely aligns with the person’s needs and there are some key shortcomings when topping up the cover.
For some clients, an opportunity exists to fund insurance in super by making partial rollovers each year into a stand-alone retail super fund.
Shortcomings of non-retail insurance
Members of non-retail super funds are usually eligible for insurance based on a fixed amount, a multiple of salary or a number of units that depend on their age. However, the amount of cover provided is not based on the person’s personal and family circumstances and rarely is it sufficient for their needs.
For instance, Rice Warner has revealed the average amount of life cover required by a family in 2015 was around $680,000, while the typical default cover was approximately $200,000.
Some non-retail super funds don’t offer income protection insurance and, if they do, the benefit payment period is often short (eg two years)
Also, non-retail policies often don’t provide many of the additional features available with retail offerings, such as:
- guarantee of upgrade, where the insurer offers new benefits and enhanced definitions to existing members
- guarantee of renewability, where the members can renew their policies regardless of changes involving their occupation, health, or activities
- buy back options, where the members can arrange to retain their life cover in the event they are totally and permanently disabled (TPD) provided they survive for a specified period rather than the TPD claim reducing the life cover sum insured, and
- continuation options or portability, which enables the members to retain the cover when they leave their employer or industry.
Because the cover is unconditional, the trustees can make retrospective changes that impact members unfavourably. For example, recently, one large industry fund retrospectively made adverse changes to the definition of disability for TPD and income protection.
Finally, there has recently been a dramatic increase in the insurance premiums charged by the non-retail sector. This is particularly the case for TPD and income protection rates, where the increases have often been over 100% in response to poor claims experiences.
Notwithstanding the above, there will be many clients who wish to retain such cover, whilst augmenting their overall coverage within super without:
- running two super funds and periodically transferring amounts from their main fund to another fund to obtain additional insurance, or
- requesting their employer contribute to two funds, noting that employers seldom agree to do this.
A possible solution
There is a potential solution that enables clients to take out additional concessionally funded insurance in super without compromising the existing cover in the non-retail fund. It involves:
- taking out a stand-alone insurance policy in a retail super fund, and
- arranging for 85% of the premium amount to be transferred from the account balance of the non-retail fund once every 12 months.
This solution takes advantage of the portability rules that have been in place for some time. However, it has become more seamless and automatic due to developments in Insurers’ product offerings and changes in the portability legislation.
Until recently, when funding premiums in retail stand-alone fund insurance schemes, such as MLC Insurance Super (MLCIS) it was generally necessary to either:
- have the stand-alone policy connected to a super investment fund (such as MasterKey Fundamentals), or
- arrange for contributions (such as employer concessional contributions) to be made into the stand-alone policy.
However, technological enhancements mean it’s now possible to seamlessly cover the cost of premiums by arranging an automatic rollover once every 12 months. This is known as establishing an ‘enduring rollover’.
Also, improvements in electronic rollover technology mean that the statutory maximum period for processing a rollover has dropped from 90 days to 3 days.
Finally, the partial rollover will not be triggered until the client’s insurance has been accepted in the retail fund, which removes a significant risk when implementing this strategy.
Notice of intent
An issue to be aware of relates to members who are eligible to claim personal tax deductions for personal contributions and make these to their non-retail super fund. If such members make their contribution(s) and then do a (partial) enduring rollover, the amount the member can claim as a personal tax deduction may be reduced as illustrated in the following example.
Assume a member has a $100,000 balance in their non-retail fund in a financial year (all taxable), makes a $25,000 contribution to this fund and intends to submit a Notice of Intention (NOI) in the following financial year to claim a personal tax deduction.
The $25,000 will be a tax-free component until such time a NOI is given to the non-retail fund. The NOI must be given before the end of the financial year following the contribution year or before the client submits their income tax return for the contribution year (if this earlier).
If in the interim period (prior to the NOI), the member does an enduring rollover to acquire $10,000 of retail fund insurance, the rollover will be $8,500 where receiving funds such as MLCIS return the 15% deduction the trustee gets to the member.
The tax-free component in the enduring rollover is:
= $8,500 x $25,000/$125,000
The remaining tax-free component in the non-retail fund is $25,000 – $1,700 = $23,300.
If the client or their adviser subsequently seeks to submit an NOI to claim a deduction of $25,000 within the above time frames:
- it will not be valid as only $23,300 of tax-free component remains; and
- a new NOI for a deduction of $23,300 will be required within those time frames if the member wishes to maximise tax deductibility.
The issues relating to partial rollovers and withdrawals generally and NOIs are set out in a tax ruling, and the calculations will differ if there are already non-concessional contributions in the non-retail fund.
It is therefore important to ensure the NOI is lodged and acknowledgment is received from the fund before the rollover is processed.
Eligible service date and tax on benefits
An enduring rollover to establish insurance in a stand-alone policy may mean that an earlier service date applies to resulting insurance-funded super benefits in contrast to members funding the policy by making concessional contributions directly to the fund (if they are able to).
This could be advantageous where the benefit is a death benefit paid to a member’s non-dependant beneficiaries (such as an independent adult child) as the taxable element of the taxable component (taxed at 20%) will increase relative to the untaxed element (taxed at 30%).
Conversely, for TPD benefits (paid under the ‘permanent incapacity’ condition of release), the enduring rollover could result in the member having an increased taxable component (taxed at 20%) relative to any tax-free component paid as a benefit. However, all permanent incapacity benefits paid to a member 60 or over will be non-assessable regardless.
Source: MLC Changes and Insights dated 8 November 2016