Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 262

Understanding disability insurance in super

The 2018 Federal Budget announcements regarding default insurance in superannuation have turned many heads in the direction of insurance. Understanding the different types of disability insurance and how they can be held inside and outside of super can assist in managing the cost of insurances and taking advantage of tax concessions.

Definitions of disability in superannuation

Since 1 July 2014, superannuation law requires that insurance issued by a super fund must have disability definitions that are consistent with the superannuation conditions of release. This is to ensure that in the event of a successful claim, the insurance payout can be accessed immediately. Prior to the change, it was possible for the trustee of a fund to receive the insurance proceeds from a successful claim, but not be able to make a payment to the member as they had not met a superannuation condition of release.

Super conditions of release include death, terminal medical conditions, permanent incapacity, and temporary incapacity. Members who were insured under inconsistent definitions before 1 July 2014 are able to retain their policies under grandfathering arrangements.

The most significant impact of the change meant that super funds cannot insure new members for own occupation permanent incapacity or for trauma insurance.

Two different insurance definitions

There are two different insurance definitions for ‘any occupation’ and ‘own occupation’:

1. Any occupation

The superannuation condition of release for permanent incapacity definition is important. It requires that the trustee of the fund is reasonably satisfied that the member’s ill health makes it unlikely that the member will engage in gainful employment for which the member is reasonably qualified by education, training, or experience. This is commonly referred to as the ‘any occupation’ definition.

2. Own occupation

The commonly used ‘own occupation’ insurance definition requires that the member’s ill health makes it unlikely that the member will engage in gainful employment in their usual occupation.

The own occupation insurance cover is more likely to result in a successful claim and many individuals will be keen to ensure that they are covered by the more flexible definition. However, the insurance will need to be held outside of super.

Policy linking in and out of super

Many super funds and insurers offer ‘policy linking’ whereby the any occupation insurance is held inside of super where the insurance premiums may be paid from the super balance and are tax deductible to the fund. The own occupation insurance is held outside of super where the premiums are not tax deductible.

Any claim is firstly assessed using the any occupation definition. If the any occupation definition is met, the permanent incapacity benefit is paid to the super fund and can then be released to the member. If the any occupation definition is not met, the claim will be assessed against the own occupation definition and if successful the insurance held outside of super will be paid to the individual.

The policy linking can avoid a duplication of insurance and generally offers a cheaper premium than would be available by holding only an own occupation insurance outside of super.

Taxation of permanent disability benefits

Tax concessions may apply where a super fund member meets the definition of a disability superannuation benefit and the benefit is paid as a lump sum or rolled over.

An additional tax-free amount is payable if the benefit is paid to a member due to their ill-health (whether physical or mental). Two legally-qualified medical practitioners must certify that because of ill health, it is unlikely that the member can be gainfully employed in a capacity for which they are reasonably qualified by education, training or experience.

Although this is similar to the condition of release definition, it has the requirement of the certification, without which the benefit may be paid from the fund but not with the tax concession.

Where a permanent disability benefit includes life insurance proceeds, the insurance proceeds will form part of the taxable component.

Lump sum tax-free uplift

Permanent disability benefits are eligible for an additional tax-free amount. The tax-free component is the sum of:

  1. the ordinary tax-free component
  2. the tax-free uplift amount calculated as:

Benefit amount X days to retirement / (service days + days to retirement)

Where the:

  • benefit amount is the total amount of benefit to be paid
  • days to retirement is the number of days from the day the member stopped being capable of being gainfully employed to their normal retirement date (generally age 65)
  • service days is the number of days in the benefit service period (usually from date joined fund to date of benefit payment)

The lump sum tax treatment is shown in the table below:

* As at 1 July 2018 and indexed annually

Case study

Jake ceased work on his 50th birthday as a result of permanent incapacity. His accumulated super balance was $200,000 (all taxable component) and he received $500,000 of insurance. He joined his fund on his 30th birthday.

If Jake withdraws all of his benefit, he receives a tax-free uplift of $300,000 ($700,000 x 15 years / (20 years + 15 years) = $300,000).

Pension payments

A disability pension paid from super does not receive an additional tax-free amount. The tax-free and taxable percentages of a pension are determined at commencement and are based on the proportion of the tax-free and taxable components of the accumulation benefit used to commence the pension. Any insurance proceeds forms part of the taxable component.

For members under age 60 the taxable component of the pension payment received is included in their assessable income and taxed at marginal tax rates. However, a 15% tax offset applies to the taxable component of each pension payment. For members age 60 and over the pension payments are tax-free.

 

Julie Steed is Senior Technical Services Manager at Australian Executor Trustees. This article is in the nature of general information and does not consider the circumstances of any individual.

 


 

Leave a Comment:

RELATED ARTICLES

The insurance essentials

Poor pricing of life insurance products and the impact on Australians

The vital role of insurance in super for disability care

banner

Most viewed in recent weeks

Raising the GST to 15%

Treasurer Jim Chalmers aims to tackle tax reform but faces challenges. Previous reviews struggled due to political sensitivities, highlighting the need for comprehensive and politically feasible change.

100 Aussies: seven charts on who earns, pays, and owns

The Labor government is talking up tax reform to lift Australia’s ailing economic growth. Before any changes are made, it’s important to know who pays tax, who owns assets, and how much people have in their super for retirement.

Here's what should replace the $3 million super tax

With Div. 296 looming, is there a smarter way to tax superannuation? This proposes a fairer, income-linked alternative that respects compounding, ensures predictability, and avoids taxing unrealised capital gains. 

9 winning investment strategies

There are many ways to invest in stocks, but some strategies are more effective than others. Here are nine tried and tested investment approaches - choosing one of these can improve your chances of reaching your financial goals.

The rubbery numbers behind super tax concessions

In selling the super tax, Labor has repeated Treasury claims of there being $50 billion in super tax concessions annually, mostly flowing to high-income earners. This figure is vastly overstated.

With markets near record highs, here's what you should do with your portfolio

Markets have weathered geopolitical turmoil, hitting near record highs. Investors face tough decisions on valuations, asset concentration, and strategic portfolio rebalancing for risk control and future returns.

Latest Updates

Investment strategies

Finding income in an income-starved world

With term deposit rates falling, bonds holding up but with risks attached, and stocks yielding comparatively paltry sums, finding decent income is becoming harder. Here’s a guide to the best places to hunt for yield.

Economy

Fearful politicians put finances at risk

A tearful Treasury chief, a backbench rebellion, and crashing bonds. What just happened in the UK and why could Australia’s NDIS be headed for the same brutal fiscal reality?

Shares

Investing at market peaks: The surprising truth

Many investors are hesitant to buy into a market that feels like it’s already climbed too far, too fast. But what does nearly a century of market history suggest about investing at peaks?

Shares

Chinese steel - building a Sydney Harbour Bridge every 10 minutes

China's steel production, equivalent to building one Sydney Harbour Bridge every 10 minutes, has driven Australia's economic growth. With China's slowdown, what does this mean for Australia's economy and investments?

Investment strategies

Will stablecoins change the way we pay for things?

Stablecoins have been hyped as a gamechanger for the payments industry. But while they could find success in certain niches, a broader upheaval of Visa and Mastercard's payments dominance looks unlikely.

Infrastructure

An investing theme you can bet on for the next 30 years

Investors view infrastructure as a defensive asset class rather than one with compelling growth prospects. These five tailwinds for demand over the coming decades suggest that such a stance could be mistaken.

Investment strategies

A letter to my younger self: investing through today's chaos

We are trading through one of history's most confounding market environments. One day, financial headlines warn of doomsday scenarios. The next, they celebrate a new golden age. How can investors keep a clear head?

Sponsors

Alliances

© 2025 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.