Many people think of life insurance as a tool for wealth protection, but it can actually be used effectively as a part of the investment strategy for an SMSF.
Currently life insurance is much underutilised with SMSFs. Recent figures suggest that only 33% of funds contain any level of life insurance, which is considerably lower than the percentage of traditional super funds holding insurance.
One of the reasons for this is that many SMSF holders believe that they do not need life insurance. They believe that their super balance is sufficient enough on its own and does not need to be supported by insurance.
For many SMSF holders this may well be true, however there is more to consider than just the fund balance. You also need to consider the assets within the fund, and particularly the liquidity of those assets.
How life insurance fits into the investment strategy
Property and some of the more exotic assets within a SMSF are not particularly liquid, and an unexpected requirement for liquidity, such as the death or permanent disability of a member, could leave an SMSF having to unload illiquid assets in a hurry.
Ordinarily the sale of illiquid assets would be planned many years in advance as part of the retirement planning process. But in the case of death or permanent disability your fund may be forced to sell at a time which is not good for the remaining fund members or the beneficiaries.
By using a life insurance policy, the SMSF can fund the member’s benefits in part of whole through the use of life and TPD insurance, meaning that there would be no pressure to sell illiquid assets at an undesirable time.
Like many Australians, Thomas and Wendy like the idea of investing in property. Because of this they decide to pool their superannuation benefits of around $150,000 each into an SMSF, then borrow another $300,000 to purchase an investment property valued at $600,000.
The purchase means that close to 100% of their combined super is invested in property. Although they understand the benefits of diversification they are both happy to be fully exposed to property.
If Thomas or Wendy were to die, the SMSF would be required to pay their individual benefit amount of $150,000. To do this the fund would have to sell the property within a short period of time.
If the property market had cooled at the time of death, the surviving partner would have to sell the property for a loss, which would be a poor investment outcome for Wendy, Thomas and their beneficiaries.
A far better investment outcome could be had by utilising a life insurance and TPD insurance policies.
Life insurance policies could be taken out for $500,000 on each life, and the investment strategy would outline the objective of the insurance as being to repay the $300,000 debt and pay a $300,000 benefit to the member’s nominated beneficiary which would include the individual’s super balance of $150,000.
This would enable to fund to pay the death benefit as required without having to sell the property and compromising the surviving member’s investment strategy. Furthermore, the surviving member would benefit by having the debt repaid in full.
Taking out life insurance within your SMSF
Both life insurance and TPD insurance can be help within an SMSF, however TPD insurance is generally restricted to an ‘any occupation’ policy definition. Trauma insurance cannot be held within an SMSF.
Taking out life insurance within an SMSF is generally no different to taking out a policy outside of superannuation. You simply have to nominate your SMSF as the owner instead of yourself.
You may also need to mention the objectives of the policy within your investment strategy document if you are planning on doing something similar to that which has been outlined in the case study above.
Proper planning and professional advice is the key to making this strategy work properly. If not setup correctly, the strategy could backfire and not give you the benefits you were hoping for.
For more information on this strategy or any other SMSF matters please speak with your financial adviser.