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

Welcome to Firstlinks Edition 433 with weekend update

There’s this story about a group of US Air Force generals in World War II who try to figure out ways to protect fighter bombers (and their crew) by examining the location of bullet holes on returning planes. Mapping the location of these holes, the generals quickly come to the conclusion that the areas with the most holes should be prioritised for additional armour.

  • 11 November 2021

Why has Australia slipped down the global super ranks?

Australia appears to be slipping from the pantheon of global superstar pension systems, with a recent report placing us sixth. A review of an earlier report, which had Australia in bronze position, points to some reasons why, and what might need to happen to regain our former glory.

Welcome to Firstlinks Edition 431 with weekend update

House prices have risen at the fastest pace for 33 years, but what actually happened in 1988, and why is 2021 different? Here's a clue: the stockmarket crashed 50% between September and November 1987. Looking ahead, where did house prices head in the following years, 1989 to 1991?

  • 28 October 2021

How to help people with retirement spending decisions

Super funds will soon be required to offer retirement income strategies for members in decumulation. With uncertain returns, uncertain timelines, and different goals, it's possibly “the hardest, nastiest problem in finance".

Tips when taking large withdrawals from super

You want to take a lump sum from your super, but what's the best way? Should it come from you or your spouse, or the pension or accumulation account. There is a welcome flexibility to select the best outcome.

“Trust your instinct” Hamish Douglass in conversation with Sir Frank Lowy AC

Sir Frank shares his story, including his journey from war-torn Europe, identifying opportunities, key character traits necessary for business success, and the importance of remaining paranoid yet optimistic.

Latest Updates

Investment strategies

20 punches: my personal investments are not a forecast

I prefer not to make market forecasts but I need to take personal investment decisions. I'm expecting a stockmarket fall in 2022 as central banks tighten policies but the mainstays in my portfolio will not be sold.

Retirement

The good news about retirement income

A lower starting withdrawal rate doesn’t always mean living on less. The latest research on sustainable withdrawals offers flexibility for retirees to improve the chances of not running out of funds prematurely.

Shares

Three small companies expected to deliver big returns

Small caps might require more work than large cap stocks but they are often worth it. After all, all large companies were small once, and there can be clear benefits of investing in and backing management early.

5 new trends driving the future of biotech companies

The biotech industry has seen an explosion of new techniques which will lead to innovative areas of growth in the use of cells and genes as medicine. Money for funding life sciences and biotech pharma has soared.

Gold

Gold and inflation: what does history tell us?

Multiple factors have seen gold fall in 2021, despite the rise in inflation. But given gold has performed strongly across longer periods of higher inflation, gold may benefit under the current inflation outlook.

  • 8 December 2021
Retirement

Solutions to unite the three pillars of retirement funding

Retirement solutions uniting the three pillars of retirement funding - the age pension, mandatory super and voluntary savings - are essential. Global experts discuss solutions that might work for Australia.

Investment strategies

New capital rules an effective vaccine for thriving banks

With stronger capital positions, improved brand equity and the potential to benefit from a robust post-pandemic recovery, the global banking sector is presenting significant opportunities for investors.

Sponsors

Alliances

© 2021 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. Any general advice or ‘regulated financial advice’ under New Zealand law has been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892) and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. For more information refer to our Financial Services Guide (AU) and Financial Advice Provider Disclosure Statement (NZ). 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.

Website Development by Master Publisher.