Income protection insurance pays a monthly benefit as a replacement of your earning if you are unable to work due to illness or injury. Holding the right type and level of insurance is essential to securing your family’s financial situation. There are several benefits of holding insurance in your SMSF, including its affordability. However, other factors should be given careful consideration, such as the associated tax consequences. When insurance premiums are tax deductible, this translates to a more affordable coverage. This is especially important when you want to gain maximum affordability of the insurance policy.
Since income protection replaces your income at the time of the claim, the Australian Taxation Office provides tax deductions for the premiums paid. The ATO assumes the benefits will be treated as income when a claim is made, hence the tax advantage. It is worth noting that income protection insurance cover premiums are tax deductible both inside and outside superannuation. This means that if you pay for premiums using concessional contributions to your SMSF, you are entitled to a tax deduction. Visit us for more info about income protection tax deductible SMSF.
Note that premiums for income protection insurance cover are only deductible if the policy pays out regular benefits as opposed to a lump sum benefit. Although lump sum benefits would be tax-free when making the claim, the premiums paid for the cover would not be tax deductible. It is also important to note that in most cases, you cannot hold income protection insurance alone in an SMSF. This is because income protection is considered an ancillary benefit and there must be a core benefit such as death cover or retirement benefits within the fund. Self-managed super funds cannot operate with the sole purpose of providing income protection insurance.
Tax deduction caps
Although income protection insurance tax deductible SMSF was in personal held policies, you might be better off holding the insurance in your name. The tax deductions are capped at 15 percent in your SMSF, but might be higher than 45 percent in a standalone retail policy. This is because the concessional contribution to super is capped, while no cap is applicable to premiums paid outside SMSF. In effect, an individual who pays for premiums for a policy held outside super may be better off than someone who pays an equal premium amount using non-concessional contributions to superannuation.
Although using your SMSF to pay for income protection insurance may seem appealing, you need to be aware of the potential limitations of tax deductible SMSF premiums. For instance, if the income protection benefit payable to a super does not meet a condition or release provided under the temporary incapacity definition, only a portion of the premiums paid by the super would be tax deductible. You would have to determine this proportion before filing for tax deductions. On the other hand, standalone income protection policies held outside superannuation are usually fully tax deductible. Before purchasing your income protection insurance, you should speak to your financial planner for a clear assessment of the potential benefits or drawbacks of obtaining your policy through your SMSF.