Arriving at the optimal choice for disablement insurance can be a complex affair, with both pitfalls and opportunities.
How to avoid the traps in TPD claims through super
Although maligned unfairly in some quarters, total and permanent disablement (TPD) insurance cover remains one of the most vital parts of the life insurance ecosystem.
In fact, its importance has increased in the wake of last year’s changes to Individual Disability Income Insurance (the sustainability measures announced by APRA in September 2021). This is especially true for high earners and professionals, who are arguably the most impacted by the APRA-mandated limits on benefits.
TPD is second only to disability income in terms of total claim payments made each year. And, according to APRA, over 90 per cent of those claims are for cover through superannuation.
Accessing these claim benefits effectively means making super fund withdrawals, which are frequently subject to some level of taxation. There are also lifestyle and non-tax considerations in choosing the best way to access these funds, depending on the claimant’s individual circumstances. Optimising this choice and avoiding potentially expensive mistakes therefore requires careful consideration of a number of complex issues.
The unique mechanics of life insurance claims through super
The mechanics of life insurance written through superannuation are different to non-super cover in a number of areas, including claims.
Rather than life insurers paying benefits directly to claimants, superannuation claims are paid to the fund trustees who then add that benefit to the life insured’s superannuation balance. At that point the claimant can choose between:
- Leaving the entire benefit within superannuation.
- Withdrawing some or all as a lump sum.
- Commencing a superannuation income stream.
Each option has its own pros and cons and will give rise to a number of different tax scenarios depending on the individual’s circumstances.
Meeting the permanent incapacity condition of release
Before making this choice, however, and in order for the trustees to authorise release of benefits from the fund, the claimant must first satisfy the permanent incapacity condition of release.
Permanent incapacity is tightly defined under superannuation law and occurs when the claimant has physical or mental ill health and the trustee is satisfied that person are unlikely to ever again engage in gainful employment for which they are reasonably qualified by education, training, or experience.
Typically, the trustees will request medical certification from two legally qualified and registered medical practitioners when making their assessment.
An important point to note here is that TPD claims under super can legally only use the “any occupation” definition of TPD, as opposed to the “own occupation” permissible under non-super policies.
Many high-earning professional clients use a linking strategy where non-super and super TPD coverage are linked together to achieve premium savings. In these circumstances it is possible for a client to be able to claim TPD under a non-super policy, but not meet the stricter “any occupation” definition under super.
Tax and Centrelink considerations
To the extent that accessing superannuation disability benefits effectively means making a withdrawal from a super fund, such withdrawals may be subject to tax, the rate of which will depend on a number of factors including one’s preservation age and the withdrawal method.
Optimising this scenario can be quite complex, especially where the claimant has multiple super funds, and the costs of making the wrong choice here can be significant.
Similarly, there can be implications for the claimant’s income-related entitlements and obligations, and any potential Centrelink impact must be weighed up. In some circumstances, amounts retained in super are exempt from Centrelink means testing, opening up the opportunity to claim a disability support pension. This opportunity may be lost if withdrawn amounts see them exceed the income or assets thresholds.
The generous tax treatment of super fund earnings is obviously appealing to many people and can be an incentive to retain funds within super for as long as possible.
The reality, however, is that some clients will need access to at least some of their claim benefit to meet everyday living expenses, to settle debts, and/or to pay for any special treatments and equipment needed as a result of their disability.
A word about SMSFs
While TPD own occupation cover as discussed above is not available through super, this change only came into effect on 1 July 2014 and it is possible for cover in place before then to be grandfathered and remain in super. Many examples of this would relate to cover taken out by SMSFs, as favoured by many high-income earners.
Despite such grandfathering being permissible, there is still a risk of a mismatch between a claimable event under the policy and superannuation conditions of release. Hence owners of SMSF funds with older insurance contracts in place should seek expert advice, to ensure they can avoid a scenario where TPD claim benefits become “trapped” in super.
The best way to structure TPD claims from super is a complex affair, filled with opportunities and potentially expensive traps. The consequences of falling into these traps is greatly amplified for high-earning professionals and reinforces the importance of expert financial advice.
Brian Pillemer is director of distribution at PPS Mutual.