David Barrett & Kelly Cox
Thursday 28 April 2016
DII in super: a tough client conversation
David Barrett & Kelly Cox
Jacqueline is a valued client that you enjoy working with, but she has a talent for asking the ‘tough questions’. She is 38 years old, a well-paid self-employed and/or contracting professional with a young family. Having an accounting background, she understands personal taxation issues well and you can talk fluently about technical issues with her.
Having done some background reading on disability income insurance (DII) after restructuring her life and total and permanent disablement (TPD) cover inside superannuation (based on your earlier advice), Jacqueline has a list of questions about how to structure her DII cover. You take a deep breath and brace yourself…
"I understand that if I pay my DII premiums directly, I am generally entitled to a tax deduction against my personal income. Why then would I have DII in my super fund? Is there any tax benefit in doing that?"
That’s right Jacqueline, generally you can claim a deduction for the DII premiums you pay directly, which at your current income level means a tax benefit of 49 per cent.
Your super fund can also claim a deduction if it pays a premium for DII cover, which attracts a tax benefit of 15 per cent, the rate at which super income is generally taxed. But if you make an equivalent contribution to your super fund, either as a deductible personal contribution or as an increased salary sacrifice contribution, you will effectively receive the same tax benefit as having paid the premium directly yourself.
So whether you pay the premium directly or via a deductible contribution to your super fund, the outcome is neutral from a tax perspective.
However, if you are already making the maximum allowable tax-deductible contributions (or more accurately concessional contributions), or if you earn more than $300,000, it won’t be tax effective to have your super fund pay the premiums.
"And what about my tax position if I have to claim benefits? Is there any advantage in having the cover inside my super fund?"
Benefit payments made to you directly from a DII policy in your own name are generally fully taxable - that is, they are treated as assessable income. The same applies for any benefits paid to you from your super fund due to your temporary incapacity, which are usually paid via a claim against a DII policy held by the super fund. So again, it is tax neutral between the two options.
"Ok, so there’s no real tax incentive. What incentive is there then?"
One potential benefit of having DII cover (as well as life and TPD cover) in super may be cash flow. If your circumstances change, for example you’re out of work for some period, and you have a cash flow crisis, then the premiums paid by the super fund may continue to be drawn from your accumulated funds within your super fund, assuming there is an accumulation of funds in your super fund. This might prevent the insurance policy or policies from lapsing, at a time when you can least afford that happening.
"I understand and that’s helpful. In my readings I noticed there were some legislative changes impacting on insurance in super effective in 2014, but I didn’t quite understand the implications. Can you explain them for me?"
The superannuation rules were changed to prohibit super funds from starting new cover arrangements from 1 July 2014 which provide benefits that are not consistent with certain existing super rules which provide access to your super benefits. The new rules ensure that new insurance policies must be broadly consistent with the super rules.
DII within super is typically aligned with the temporary incapacity super rules, which require that:
- you have ceased to be gainfully employed because of temporary, physical or mental ill-health which can include where you continue to be employed, but have temporarily ceased receiving remuneration, and
- any benefits are paid as a non-commutable income stream for the purpose of continuing the remuneration you were receiving before the temporary incapacity and the income stream can only be paid while you are incapacitated.
These super rules limit the range of benefits that can paid by a super fund when compared to the range of benefits available from non-super related DII policies.
"Limit the range of DII benefits in super! What do you mean by that?"
Yes, it is important to understand the limitations of DII policies in super. DII policies available within super from 1 July 2014 generally cannot provide all the benefits and features that are available outside super, for example:
- specific injury benefits such as benefits paid in relation to a specified medical event like a fracture, or loss of sight in one eye
- extra benefits such as those benefits provided to cover home care expenses, rehabilitation expenses or trauma cover for specific medical conditions.
Super law requires that temporary incapacity benefits can be paid only where gainful employment has ceased because of ill-health, which may be in conflict with policy benefits payable without a requirement to cease work, such as those mentioned above.
The super law also requires that temporary incapacity benefits are paid as a non-commutable income stream, paid at least monthly, with variations capped at the lesser of inflation and five per cent per annum. Benefits cannot be paid as a lump sum.
"You said earlier that the super benefits can only be paid for the purpose of continuing the remuneration I was receiving before temporary incapacity. What if I’m unemployed and then become temporarily incapacitated?"
For a benefit to be paid, you must have ceased to be gainfully employed because of your ill-health. If you are unemployed at the time of disability, you may have ceased employment for a reason other than ill-health, for example because of redundancy, a fixed term contract ending, or changing employers.
To be compliant with the new law, DII policies that commenced within super from 1 July 2014 require that the insured person is employed at the time of disability - if they're not employed, a benefit cannot be paid.
An example might help. Let’s presume you have been engaged in contract work for several years. After finishing one contract and prior to securing your next contract, you become ill and are unable to work for several months. Your employment ceased because your previous contract ended, rather than because of ill-health.
Because the proposed DII cover within your super fund would be taken out after 1 July 2014, you must be employed at the time of temporary disability for the insured benefit to be paid, so it follows that no benefits would be payable.
"My income tends to fluctuate, so how is the level of benefit calculated? I don’t want to be paying for cover I can’t receive if I make a claim."
Yes, a very understandable concern. The benefit paid cannot exceed the income being received prior to illness or injury – often referred to as your ‘pre-disability income’. If you are disabled when your income is low, you could be disadvantaged.
There is no legal guidance available to suggest what period pre-disability income should be measured over, so it’s up to each fund trustee to determine its own rules. I understand that some super funds use the 12 months prior to the disability, whereas other funds use the highest average income over any 12 month period in the 36 months prior to the disability. And other interpretations may exist also.
So, let’s say your income has been $7,500 per month for the last 12 months, but in the previous year it was $10,000 per month and $12,500 per month in the year prior to that.
If your super fund uses the highest average income for any 12 month period in the 36 months prior to disability, the maximum benefit payable by the fund would be $12,500 per month.
However, if your fund uses the average monthly income in the 12 months prior to disability, the maximum benefit payable would be only $7,500 per month.
"Ok, to be sure I should check that out with my fund.
My husband has been with his current employer for more than six years, and has never had to take a day of sick leave, so he has plenty accrued. How does that affect his DII cover, if he was to start a policy via his super fund?"
The super rules require ceasing of gainful employment, at least temporarily, due to ill-health. So if your husband was unable to work because of illness or injury, but continued to be in paid employment because of his sick leave entitlements, he may have difficulty accessing DII benefits through his super fund. This issue is a challenge both for those who are still receiving some form of income from their employers, such as paid sick leave, and those who have simply reduced their working hours because of their ill-health.
The meaning of ‘temporary cessation of employment’ is not defined in the super rules. Different funds may, therefore, adopt different positions on this issue. Some funds may require members who have a continuing employment arrangement to take at least one day of unpaid leave as a result of their illness or injury before the fund will pay a benefit.
Let’s look at your husband’s position a bit more closely. He has accumulated a large amount of sick leave. Suppose he becomes severely injured and requires two months off work to recover, but has enough sick leave to cover his entire absence. He returns to work after two months, but only works part-time because of the injury.
While he has not been working, he has been on paid leave and is therefore unlikely to meet the temporary incapacity criteria. If he doesn’t meet the criteria, a benefit cannot be paid to your husband from the super fund.
"That’s not very attractive for him then."
Well, no, but he may choose a DII policy with a longer waiting period to suit his circumstances. The waiting period is the time from disability until the insurer starts to pay a benefit. The longer the waiting period, all things equal, the cheaper the premium should be.
So if your husband has say 12 weeks of accrued sick leave, then he could elect for a DII policy that involves a three month waiting period, which will be cheaper than a policy with a 30 day waiting period.
"You’ve talked a lot about temporary disability. What if I or my husband are involved in a car accident, one of us becomes a quadriplegic and hence be unlikely to ever return to work – am I right to assume I’d be entitled to the same monthly benefits?"
Well, that is a very difficult question. Strictly speaking, for your DII benefits to be paid as a temporary incapacity benefit, the super rules require that you have ceased to be gainfully employed because of your ill-health, but that ill-health does not constitute permanent incapacity.
The super law states that permanent incapacity occurs if, because of your ill-health, you are unlikely to engage in gainful employment for which you are reasonably qualified by education, training or experience.
If you became a quadriplegic, it is most likely that you would be permanently disabled and won’t meet the requirements for temporary incapacity, so a temporary incapacity benefit could not be paid.
However, because it is likely that you would be treated as permanently incapacitated, your super fund may be able to pay the DII benefits (initially paid into the fund by the DII insurer) as a permanent incapacity super benefit, or some other type of super benefit payment.
Furthermore, it is unclear whether a super fund can continue paying a temporary incapacity benefit if you subsequently become permanently incapacitated, where the benefit was initially paid due to temporary incapacity.
"Oh, this all sounds very confusing. Can I summarise what I think you’ve told me today about having DII cover in my super fund?"
- Firstly, there isn’t really any tax benefits in having it in super – but it could be worthwhile if I had a cash flow crisis.
- The DII benefit range is generally narrower in super compared with a DII policy I might have outside super.
- I might not get paid a benefit if I’m disabled when I’m unemployed or between contracts and I could be disadvantaged if my income is lower at the time of making a claim.
- And I might be precluded from receiving a DII benefit from my super fund if I’m permanently disabled rather than temporarily.
Is that all correct?
Yes, that is a good summary of what we’ve discussed Jacqueline.
One way of overcoming these challenges is to take DII cover outside of superannuation. Another alternative is to put in place a split cover arrangement between super and non-super.
But let’s leave that discussion for another day…
For more information, check out the MAStech Guide: The ins and outs of insuring through superannuation
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