Holding life insurance cover inside an SMSF and funding the premiums from a reversionary account-based pension can give a surviving spouse the ability to establish an income stream well in excess of the $1.6 million dictated by the transfer balance cap (TBC), a technical manager has said.
Speaking at the recent SMSF Association Technical Day Series 2018 in Sydney, AIA Australia technical manager Natasha Panagis said the situation presents itself as a result of a combination of a few pieces of legislation, as well as the ATO’s confirmed treatment of life insurance proceeds.
“Although we can’t actually add to a pension interest once it’s commenced by the way of contribution, other additions are possible and those additions are investment earnings. Now the tax regs [Income Tax Assessment Regulations] actually define insurance proceeds as investments,” Panagis noted.
“The super legislation [Superannuation Industry (Supervision) Regulations 5.03(2) and 5.02(3)] says that both investment earnings and costs must be allocated or distributed in a fair and reasonable manner to members of the fund.
“So what does fair and reasonable mean? The ATO defines that, specifically in regard to this situation in regard to insurance premiums and corresponding proceeds, if an insurance premium was debited from a particular fund account, then it would be fair and reasonable for those proceeds to go back in to that account.
“They confirmed that in their NTLG (National Tax Liaison Group) meeting in September 2009 and further reconfirmed that in another NTLG meeting in June 2012.
“So the tax legislation is okay with it, the super legislation is okay with it and the ATO is fine with it.”
This would allow a surviving beneficiary of the reversionary pension to commence their own account-based pension well above the $1.6 million TBC, she said.
She illustrated this through an example where the deceased member’s reversionary account-based pension was worth $1.6 million at the time of death and the member had taken out life cover of $1 million where the premiums had been paid from that same pension.
Assuming the surviving member had no pension in place, and that the insurance proceeds were paid out within 12 months of the deceased member’s death, the surviving member could commence a pension to the value of $2.6 million, she said.
The reason being the proceeds from the life cover would be treated as investment earnings and would not count towards the surviving member’s TBC, she said.
She emphasised the strategy could only work if the deceased member’s pension was reversionary because only under those circumstances could the surviving member commence their pension 12 months after the deceased member’s death, which would allow enough time to incorporate the insurance proceeds.
“This could prove to be a great strategy for those clients who are in retirement phase, who do require insurance cover, and will allow the beneficiary to continue having a pension upon their death,” she said.
“It’s quite common these days to have clients who are pre-retirees close to retirement and still carrying a whole lot of capital debt, so it does suit that type of client.”