Life insurance through super: A definitive guide

One main benefit of life insurance inside super is that you don’t have to undergo a medical or provide health information, so you automatically are covered. Super funds have contracts with insurers (underwriters) with whom they purchase bulk (group) policies at a discounted rate, passing on the savings to you. The insurance risk pool is shared evenly among all fund members, rather than your risk being assessed directly as it would be for a standalone policy outside of super. As a result, premiums are generally lower for life insurance inside super than for a standalone policy you buy directly with an insurer or through a broker.

Life insurance in super is also beneficial from a cash-flow perspective – premiums are debited directly from your super balance, and not your bank account. The downside of your super paying for insurance is that it can eat into your super returns, and therefore impact your income in retirement, although continue reading for tips on how to minimise that.

How life insurance cover works

Life insurance cover is cheapest for younger people. The premiums increase with age, and then reduce again at older age as funds reduce the default level of cover.

Average premium costs can vary between $200 to $500 per year, depending on age and level of cover held. In fact, there is surprisingly a very large difference between the cheapest and most expensive cover. In our article on the cheapest super funds for life insurance even the 20th cheapest fund is generally 50-100% more expensive than the cheapest fund.

Funds often offer a choice between unitised and fixed cover.

• Unitised cover is where the cost of each unit of cover stays the same over time, however, the amount of cover you get for each unit reduces as you get older.
• Fixed cover involves an increasing cost of over time, but the insurance level stays the same until a certain age set by the fund (e.g. from age 60 and up).

Note that unitised cover may leave you underinsured as you get older, so carefully assess how much cover you need.

Most funds allow you to increase or decrease your cover and are trying to be more innovative and flexible with their options. If you do decide to increase your cover, you will be asked for some health information since the fund’s insurer is taking on more risk than what was assessed in the default (group) cover we mentioned above. There may be subtle differences between retail, corporate and industry super funds, for example, but generally there are commonalities in the approaches.

Transferring your life policy from one fund to the other can be problematic, but funds seem to be allowing this more and more, subject to quite a few rules and requirements to be met. Don’t cancel your existing cover until your new cover, and structure you want, is in place.

How much cover can I apply for?

Most super funds only offer default cover of between $100,000 to $400,000, and not often beyond that. Even though that figure has risen substantially since the introduction of super, that may not be enough depending on your level of financial commitments. Some industry commentators mention a figure of $1 million as more appropriate, but it really depends on your level of financial commitments.

Some funds will allow up to $3 million or $5 million for life insurance, and some have no limit. The more cover you apply for, the more stringent the risk assessment and higher the premiums. If you are in a high-risk occupation, such as a blue-collar worker in a hazardous environment, this may become an issue if you apply for higher cover. Risk loadings apply to blue-collar occupations and smokers, for example, but not generally to white-collar work.

How much life insurance is adequate?

This depends on several main factors, such as your health, income levels, financial commitments and number of dependents. As a healthy single person earning a high income, you may need less cover than a person who has a spouse, young family and a mortgage.

The main goal of life insurance essentially is to provide financial protection to the dependents of someone who dies. So, the next step is to work out how much money may be needed if you die, to either support dependents or pay off debts.

The questions then become:

• If my fund doesn’t provide enough default cover for me, what is the maximum amount of cover I can apply for and how much will it add to my premium costs?
• If my fund still doesn’t provide enough extra coverage, or I am unable to obtain it for some reason, what are my options to ensure I have enough life insurance?

Assessing all the options

Firstly, you may be able to login and view your insurance cover on your super fund website, including the cost of your premiums, normally debited monthly.

For casual workers or those with low balances, make sure your super balance is not eroded by insurance premiums. There are industry plans afoot announced in the last Federal Budget to make insurance opt-in for those aged under 25, and some funds already do this.

It may be tempting to cancel your cover at a young age or if you have a low balance, but you may be in a risky occupation, or your life circumstances may change, and it may be more difficult to opt-in to the same fund at a later date.

Some funds may allow you to increase your cover by a percentage, say 25%, for specific life event benefits, such as divorce, remarriage or a child starting school.

There is also the option of having another insurance policy outside of super, as they can co-exist together. It will cost you in premiums, but it may suit you if a large amount of cover is needed. Your beneficiaries can claim under multiple policies assuming you are not overinsured and that your providers know that you have multiple coverage.

Some companies offer flexi-linking where you can link your life cover in super with linked TPD Cover (inside and outside super) or linked trauma cover (outside super only). It can save on premium costs but any TPD or trauma payout may mean your life insurance benefit is reduced. Funeral insurance, outside of super, is also offered by some insurers which pays a lump sum to pay for funeral and related expenses.

How do claims and waiting periods work?

Claims are rising. APRA statistics show that for the year ended June 2018, the industry received 16,777 claims for a total of $2.75 billion. That’s an average of roughly $164,000 per claim, which is up from $124,657 for the period 2013-2016.

Claims are generally straightforward on paper: when you die, and assuming you have nominated your beneficiaries, the insurer pays the fund the insured amount, who then remits the proceeds to your beneficiaries as a superannuation death benefit. This is essentially the waiting period.

According to MoneySmart, across the industry the claims acceptance rate for 2017/2018 was 97.9%, and the average claim time was 1.3 months. This can vary significantly by insurer though.

If you haven’t made a binding or non-binding nomination, this can be more complicated since the super fund trustee then has the discretion to choose who to pay the insurance benefits to, which could mean to your estate where it may be legally challenged.

You can also claim if you have a terminal illness, and on compassionate grounds, subject to the terms and conditions of the policy and the fund.

To make a claim, contact your super fund directly as they all have dedicated claims specialists. You will only receive a claim if you meet the criteria of release stated under the fund’s terms and conditions, including:

• Satisfying the fund’s insurer’s definition of a claimable event.
• Meeting the super fund’s definition of release.

Some funds will not pay claims if a balance has fallen below a certain level or no contributions have been made in a certain period. Make sure you read the Product Disclosure Statement (PDS) available on the fund website. It can be a long document, but reading the fine print can save you time, stress and money later.

Life insurance claims are usually more black and white than TPD or income protection, which can have complex definitions and conditions built into their policies.

If for some reason you are not happy with a life insurance situation inside super, the first step is to contact your fund directly and raise your issues. If this doesn’t help, you can then contact the Australian Financial Complaints Authority (AFCA). This may help if you believe premiums were incorrectly calculated, any information was misleading, or a claim has been denied, for example. A final step would be to engage a lawyer in extreme cases, but due to the cost and stress involved, this is not a desirable option.

Taxes and estate planning

Super funds can generally claim a tax deduction for life insurance premiums, which they claim on your behalf and may pass on to you depending on how they account for the deduction based on ATO rules.

If you don’t want the cost of life insurance premiums to reduce your superannuation savings, you can salary sacrifice the cost of the premiums. This can be tax-effective for workers on the lower income tax rates. This also applies to the self-employed, who can claim a direct tax deduction on their life insurance.

A life insurance payout to a loved one or a dependent is not taxed, unless it goes to a non-financial dependent such as an adult child, in which case tax of 15% or more may apply. Reducing the taxable component of a superannuation balance prior to death and increasing the tax-free component is a common way to reduce or remove death benefits tax. This is a complex area so a financial adviser and lawyer can help you set up structures to minimise the tax implications as part of an estate planning strategy.

Katie Whiffen, Independent Financial Adviser from The Retirement Blueprint, discusses the importance of the client taking control of their own circumstances, rather than letting the fund trustee or ATO decide.

“To put control back to the client, if they have life insurance inside super, I highly recommend the client put in place a binding nomination. It must be valid however – there are only certain people you can bind the trustee to pay benefits, but this does include paying it to your estate. Make sure the nomination is valid at the time the nomination commences and at the time of your death, so make sure it is updated at least every two years,” she says.

“Likewise, nominations for insurance benefits outside super are not estate assets – payments are paid directly to the beneficiary, by-passing the estate (and your will). This provides significant control of the flow of insurance proceeds. Of course, your estate can be the direct beneficiary of your insurance proceeds,” Whiffen added.

“Another area that is often overlooked is the significant estate planning and potential tax benefits to holding insurance inside super, depending on your circumstances. For example, let’s say you have a $100,000 super balance, a $1 million life insurance policy inside super and a 12-year-old child. If you die, the child could either take this as a tax-free lump sum (presuming this is tax-free, or the taxable component taxed) or it could be provided as a
tax-free income stream to the child until they are 25, at which time the balance is provided tax-free. From a tax perspective, this has a large advantage over a situation where the policy was outside super. In this instance while the benefit is still tax-free, if this is used to generate an income for the child, the income earned is likely to be assessed at minor rates (45%),” Whiffen elaborates.

Whiffen also reinforces what life insurance really is about for a client. “What you are looking for with insurance is the right money, going to the right people at the right time. It must also be affordable for the client’s circumstances”.

“To date, super has been a great way to increase the perceived affordability of a good insurance plan, as it is paid from super and it doesn’t impact the client’s current cash flow. It doesn’t mean that this is always the best way to hold insurance,” she noted.

Next steps: Your life insurance checklist

To decide what life insurance strategy inside super works for you, here’s a quick checklist:

• Jump online, review your cover and read your fund’s insurance documents.
• Assess whether you need to increase, decrease or change your cover based on your current life and financial circumstances. It may be necessary for you to speak to a financial adviser or your super fund to get a better understanding of what they recommend for your circumstances.
• Check the terms and conditions for each policy you hold, as super funds are generally becoming more stringent in these areas.
• If you haven’t already, decide who your beneficiaries will be and ensure any binding nominations are kept up to date.
• Weigh up the option of having another life insurance policy outside of super if you need significant cover.
• Taxation of life insurance proceeds from super is a complex area, so seek financial and legal advice when setting up an optimal estate planning structure.
• Avoid the temptation to transfer or cancel your cover without reading the conditions involved in such actions. It helps avoid underinsurance, not being covered at all, and problems if the need to claim arises.