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

Is it better to rent or own a home under the age pension?

With 62% of Australians aged 65 and over relying at least partially on the age pension, are they better off owning their home or renting? There is an extra pension asset allowance for those not owning a home.

Too many retirees miss out on this valuable super fund benefit

With 700 Australians retiring every day, retirement income solutions are more important than ever. Why do millions of retirees eligible for a more tax-efficient pension account hold money in accumulation?

Is the fossil fuel narrative simply too convenient?

A fund manager argues it is immoral to deny poor countries access to relatively cheap energy from fossil fuels. Wealthy countries must recognise the transition is a multi-decade challenge and continue to invest.

Reece Birtles on selecting stocks for income in retirement

Equity investing comes with volatility that makes many retirees uncomfortable. A focus on income which is less volatile than share prices, and quality companies delivering robust earnings, offers more reassurance.

Welcome to Firstlinks Election Edition 458

At around 10.30pm on Saturday night, Scott Morrison called Anthony Albanese to concede defeat in the 2022 election. As voting continued the next day, it became likely that Labor would reach the magic number of 76 seats to form a majority government.   

  • 19 May 2022

Comparing generations and the nine dimensions of our well-being

Using the nine dimensions of well-being used by the OECD, and dividing Australians into Baby Boomers, Generation Xers or Millennials, it is surprisingly easy to identify the winners and losers for most dimensions.

Latest Updates

SMSF strategies

30 years on, five charts show SMSF progress

On 1 July 1992, the Superannuation Guarantee created mandatory 3% contributions into super for employees. SMSFs were an after-thought but they are now the second-largest segment. How have they changed?

Investment strategies

Anton in 2006 v 2022, it's deja vu (all over again)

What was bothering markets in 2006? Try the end of cheap money, bond yields rising, high energy prices and record high commodity prices feeding inflation. Who says these are 'unprecedented' times? It's 2006 v 2022.

Taxation

Tips and traps: a final check for your tax return this year

The end of the 2022 financial year is fast approaching and there are choices available to ensure you pay the right amount of tax. Watch for some pandemic-related changes worth understanding.

Financial planning

Is it better to rent or own a home under the age pension?

With 62% of Australians aged 65 and over relying at least partially on the age pension, are they better off owning their home or renting? There is an extra pension asset allowance for those not owning a home.

Infrastructure

Listed infrastructure: finding a port in a storm of rising prices

Given the current environment it’s easy to wonder if there are any safe ports in the investment storm. Investments in infrastructure assets show their worth in such times.

Financial planning

Power of attorney: six things you need to know

Whether you are appointing an attorney or have been appointed as an attorney, the full extent of this legal framework should be understood as more people will need to act in this capacity in future.

Interest rates

Rising interest rates and the impact on banks

One of the major questions confronting investors is the portfolio weighting towards Australian banks in an environment of rising rates. Do the recent price falls represent value or are too many bad debts coming?

Sponsors

Alliances

© 2022 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.