Most of us need; income protection, life insurance, total & permanent disability insurance or trauma insurance at some stage of our lives. If you are going to the effort of getting insurance then it makes sense to get the cover that is right for you. Here are some tips and traps to keep in mind.
I have based this blog on an article recently published in the Financial Review’s Smart Investor magazine (5 June 2012) under title ‘5 more insurance traps to avoid’.
Paying tax on life payouts in super
Having your life insurance in super has its advantages. For example, you don’t have to fund the premiums from your day to day cash flow. However, if your insurance is in super you may end up paying a lot of tax. If you die and your insurance is held inside and you have nominated your spouse, underage children and/or financial dependants as the beneficiaries super there is no tax to pay. However, if the payment goes to anyone else (e.g. your grown-up children) there’ll be tax to pay.
Another trap to keep in mind is that if you change super funds you can’t take the insurance with you.
Ending up with inferior Income Protection (IP) cover inside super
- If your marginal tax rate is higher than 15 per cent its cheaper to own IP outside super rather than inside.
- A lot of super fund income protection benefits cut out after two years.
- While insurance policies within super are typically cheaper they can come with a lot of conditions. For example:
- There may be a ‘lump-sum offset’. That is, the monthly income amount gets reduced because you receive a one-off payment.
- If you have Total & Permanent Disability (TPD) Insurance and Income Protection (IP) Insurance with the same fund you might think you’re eligible for a lump sum plus a monthly salary replacement but you might not be. The TPD contract could specify that your lump-sum payout will be converted into a monthly income over a number of years. For example, a $300,000 lump sum payout might be paid to you over five years at $5000 a month. If you have IP with the same fund the TPD could well be offset against the monthly income protection payment
- One view is that you should also have IP outside super (even if it overlaps with cover in the fund). That’s fine but you can’t insure more than 75% of your salary. If you have more than one insurer you could end up with duelling insurers. Your insurers may delay payment haggling over who pays what. Also, if you didn’t tell insurer B about the income protection policy with provider A, then B might decide it doesn’t have to pay. That means more delays and potentially another trap
It’s all there in the contract – ask your adviser to take a look.
Issues with TPD inside super
There are two types of occupation definitions for TPD cover. Have a look at the occupation definition within your TPD policy very carefully as own occupation TPD cover might not be completely tax deductible inside super.
- “Any occupation” definition. For this policy to pay out, you must not be able to do all forms of work for which you’re reasonably suited according to your training, experience and education.
- “Own occupation” definition. For this policy you must be incapable of ever working again in just your current occupation.
- TPD payouts can become trapped inside super if you don’t meet a superannuation ‘condition of release’.
- There will be tax to pay whenever a TPD payment is paid to you from a super fund.
Shopping on price
We all want a good deal. But going for the cheapest insurance can get you into trouble. Insurers price their products based on the terms of the contract. The more they offer the customer, the more expensive they will be. The more conditions and exceptions, the lower the level of cover and the longer the waiting periods, the cheaper it will be. In other words, you get what you pay for. It’s like choosing cut-price brakes for your car – it may seem like a good idea at the time, but not when you’re about to hit the truck in front of you.
Failing to review your needs
As circumstances change, so do insurance needs. Here are some examples:
- You may have taken out insurance when you were single with no dependants. You may now be married with a young family and mortgage.
- Income protection is a necessity for a young person whose biggest asset is their capacity to earn income as they have a lot of working years ahead of them. However, for someone whose main working years are behind them it may not be worth protecting their income
- Your income and expenses may have changed dramatically since you first implemented your IP cover. You might find that the cover isn’t enough to fund your lifestyle
A final note: be totally honest when talking to your insurers. If you smoke, tell them so.
And if something that might affect eligibility happens after you lodge your application but before it’s approved (which can take some months) tell the insurance companies about it and continue to keep them up to date – otherwise they could use it as a valid excuse not to pay a claim years later.
Plenty of food for thought. Please give me a call if you would like to discuss further.
Bye for now