
Annie Dawson
Senior SMSF Technical Specialist
When an SMSF receives an insurance payout under an income protection policy, the insured member will quickly want to know if they can access the benefits and what the tax consequences are.
When an insurance payout occurs, there are a few important issues to be addressed. Let’s start with the obvious one - how should the insurance proceeds be handled?
If the SMSF has received the proceeds as the owner of the policy, the good news is that the proceeds are generally not treated as assessable income of the fund. And any capital gain will be disregarded for policies insuring against an individual suffering an illness or injury provided the SMSF is a complying superannuation fund.
But how do the insurance proceeds find their way to the member’s account? Under super law, insurance proceeds form part of the fund’s investment return. In line with the requirement to take a fair and reasonable approach, trustees would usually allocate the insurance proceeds to the member account from which the premiums have been deducted. That includes any refund of insurance premiums as well.
Can the money be paid out to the member straight away? Not necessarily. Just because the insurer has accepted and paid the fund’s claim, doesn’t mean the member will be able to access benefits. The trustee will need to determine if a member has met a condition of release before cashing a benefit. If the member hasn’t yet retired or reached age 65, they will need to determine whether the member’s injury or illness has caused them to be permanently or temporarily incapacitated for super law purposes.
This is an important distinction as it will impact whether the member can access some or all of their benefits, the payment options available and how the benefits will be taxed in the hands of the member.
For example, to qualify for a temporary incapacity benefit under the super rules, a member must:
- cease to be gainfully employed as a result of ill-health or temporarily stop receiving income (ie they can’t work, have had all their personal leave paid out but are still regarded as an employee by their employer), and
- not be permanently incapacitated.
In addition, the trustee must generally only pay the insurance proceeds (and not the member’s accrued benefits) to the member:
- as an income stream benefit (at least monthly), and
- to replace the gain or reward the member was receiving from gainful employment before ceasing work due to the injury.
Asking for evidence of a member’s pre-incapacity earnings is a good starting point for a trustee to work out what benefit they will be permitted to pay.
And if a temporary incapacity benefit is payable, be warned - the taxation of benefits is a little unusual! For tax purposes, the benefit received by the member is taxed like salary and wages (any tax free component is ignored). The fund will need to:
- register for PAYGW,
- withhold tax using the tables applicable to salary/wages (it’s not a super lump sum benefit), and
- issue an ordinary payment summary (not a super one).
And despite the super rules requiring the temporary incapacity benefits to be paid as a non-commutable income stream, this will not qualify as a retirement phase pension. This means the fund will not be entitled to exempt current pension income when cashing this benefit nor is there any reporting for TBAR purposes (which is why in practice we leave the member’s account in “accumulation” phase if their benefits are preserved).
As you can see, insurance payments can be a huge help, but they come with obligations. Need help navigating the finer details? Be sure to complete our online Super Specialists’ courses so you can help manage what can be a difficult time with care and confidence.
This article is for general information only. It does not constitute financial product advice and has been prepared without taking into account any individual’s personal objectives, situation or needs. It is not intended to be a complete summary of the issues and should not be relied upon without seeking advice specific to your circumstances.