A major windfall?
Unlike life insurance held through retail superannuation funds, insurance held through a Self Managed Super Fund (SMSF) can provide a unique tax planning opportunity. So, if an SMSF member has made a death or TPD claim in the financial year, it may be valuable to consider claiming a special type of tax deduction that could allow the SMSF to create a tax loss for the fund - which can also be carried forward to future years.
Typically, we would expect to see a superannuation fund claim a tax deduction each year for the amount of insurance premium that it has paid during that year when completing its annual tax return. However, for SMSFs, there is an alternative which carries some serious punch!
The alternative, which is only practically available to SMSFs, is contained within section 295-470 of the Income Tax Assessment Act 1997.
To determine the size of the tax deduction available under this alternative, we need to apply the following simplified formula:
Amount of benefit paid = Future Service ÷ Total Service
Future service relates to service remaining to age 65; and
Total service relates to service already completed, plus future service.
Importantly, an election must be made not to claim a tax deduction for the insurance premiums the SMF has paid in the year of death or incapacity;
How it works – a case study
Let’s take a closer look through a short case study:
Michael has been a member of his SMSF for 30 years. He dies at age 50, during the 2010/11 financial year. At that time, Michael’s death benefit (including insurance cover of $1 million) was $2.1 million.
Up until the 2010/11 year, the fund has regularly claimed the annual cost of insurance premiums as a tax deduction through its annual tax return.
However, in the 2010/11 financial year, instead of claiming a tax deduction for the premiums paid during that year, the SMSF makes an irrevocable election to claim a tax deduction (under section 295-470) as follows:
$2.1 million x 15 years ÷ 45 years = $700,000
By choosing not to claim the 2010/11 insurance premiums as a tax deduction, and claiming a tax deduction under this alternative method, the fund will receive a tax deduction of $700,000.
The benefits could be sizeable
A tax deduction of this size is likely to wipe out any Capital Gains Tax incurred by the fund on asset disposals required to pay out Michael’s death benefit.
Further, any remaining tax deduction is likely to create a tax loss for the fund which can be carried forward and used to reduce the funds taxable income in future years. This could result in the fund not paying tax on future investment earnings or on taxable contributions (such as salary sacrifice etc) for some years to come.
Importantly, this is also available where the payment was made as a result of permanent incapacity (i.e. not only death benefits). Indeed, it would also be available to the fund where the death/disability benefits was paid in the form of a pension instead of a lump sum (although its effectiveness may be reduced where this is the case).
This may be a powerful tax planning tool that arises through holding insurance inside an SMSF!
IMPORTANT: As this information does not take into account your specific circumstances, we ask that you seek the professional advice of your qualified tax accountant to determine that this is applicable to your situation and suitable to your particular needs.