Life insurance and superannuation are often treated as separate fields as they have different overall aims but they are increasingly starting to overlap.
As Rachel Leong from BT Financial Group writes recent changes to the pensions rules relating to superannuation mean that life insurance advisers need to be aware of the impact a policy benefit can have on their client’s retirement or estate planning.
Getting the life insurance right but the superannuation wrong may have very costly implications for the future.
Significant changes to superannuation law, effective 1 July 2017, have broad implications for estate planning strategies. As life insurance is often a critical part of estate planning, advisers need to consider the effect of these changes on existing and future life insurance advice.
One of the main changes is the introduction of the $1.6 million transfer balance cap, which limits the amount of super that can be used to commence a pension. This has implications for death benefit pensions; with different rules applying for discretionary and reversionary death benefit pensions, and child pensions.
Discretionary death benefit pensions and term life policies
A discretionary (non-reversionary) death benefit pension may commence when the dependent beneficiary has given specific instructions; or when the trustee is acting on guidance or a binding nomination, provided by the deceased before they pass away.
Where the trustee commences a death benefit pension that is not a reversionary pension, the commencement value of the pension counts as a credit towards the transfer balance account on the date that the death benefit pension commences.
The commencement value includes any investment earnings accrued to that point, including proceeds from a term life policy — regardless of whether the policy was held in the accumulation or pension phase of the deceased member.
As life insurance is often a critical part of estate planning, advisers need to consider the effect of these changes on existing and future life insurance advice
If a discretionary death benefit pension is paid, where superannuation savings and term life proceeds are in excess of the transfer balance cap, the excess will need to be paid out from superannuation as a lump sum. Therefore, while it may be beneficial to fund the full sum insured inside superannuation for affordability reasons, the entire insurance payment may not be retainable inside superannuation. There are also circumstances in which no portion of the life insurance payment can be retained inside superannuation.
The example below illustrates the impact of the new transfer balance cap where a death benefit exceeds $1.6 million. In this type of scenario, the adviser will ultimately need to consider how the excess amount will be invested outside super.
Lisa and Thomas are de facto spouses, both age 60, who have their superannuation and life insurance cover within a retail superannuation fund. Lisa has made a binding death benefit nomination, with Thomas listed as the beneficiary for 100% of the benefit. Thomas has done the same for Lisa.
Lisa has an accumulated superannuation balance of $300,000, and term life and TPD cover of $800,000. Thomas has an accumulated superannuation balance of $800,000, and term life and TPD cover of $1.5 million.
Thomas passes away in August 2017. To manage cash-flow, Lisa requests Thomas’ super fund pay $1.6 million of the death benefit to her in the form of a pension, to ensure she remains within the transfer balance cap. After considering Thomas’ binding nomination to Lisa, as well as her request, the trustee decides to release this portion of the death benefit to Lisa as a pension. The balance of the death benefit ($700,000), is paid to Lisa as a lump sum.
Lisa has exhausted her lifetime cap by setting up this pension and will not be able to commence a pension with her own superannuation.
Reversionary death benefit pensions
A reversionary death benefit pension is a pension that commenced in the name of the deceased and, upon their death, continues, but in the name of their nominated dependent beneficiary. The pension does not cease at any point, as the reversionary beneficiary is immediately entitled to receive payments.
In this scenario, for pensions that reverted on or after 1 July 2017, a transfer balance credit equal to the value of the reverted pension on the date of death, will show in the transfer balance account 12 months after the date of death. The 12-month grace period allows the dependent beneficiary enough time to rearrange their superannuation interests to ensure that they do not breach the transfer balance cap.
Any life insurance proceeds paid from a policy held in the pension account will be paid after the date of death. Therefore, it appears that these will not count towards the transfer balance cap. Industry guidance has not clarified this point, and thus a private ruling may be required.
The rules differ for child pensions derived from a parent’s death benefit. The child’s transfer balance cap, i.e. ‘cap increment’, refers to their portion of the parent’s retirement phase interests. Once the child pension ceases, the child’s transfer balance will extinguish, and they will be able to use a second transfer balance cap as an adult.
If the child pension commences after 1 July 2017, the applicable transfer balance cap will depend on whether the parent had a transfer balance account or not. A transfer balance account will exist for the parent if they had an existing pension at their date of death, or they had previously commenced a pension that they subsequently exhausted.
If the parent did not have a transfer balance account and they passed away on or after 1 July 2017, the child’s transfer balance cap is their portion of the parent’s superannuation interest (including life insurance proceeds) multiplied by the general transfer cap ($1.6 million (2017/18)). For instance, if the deceased adult has four children, each could commence a pension with a maximum account balance of $400,000 ($1.6 million/4).
If there is a superannuation balance available, and the term life sum insured is large, it is possible that not all proceeds will be payable as a pension. The remainder will need to be paid to the child(ren) as a lump sum.
On 1 November 2017, Bradley dies at age 50, with an accumulated superannuation balance (after payment of term life insurance proceeds) of $2.5 million. Bradley previously made a binding nomination to ensure his full death benefit is paid to his two daughters from his first marriage. Laura (age 12) and Jenna (age 14) are to receive his death benefit in equal shares.
Laura and Jenna are able to commence child pensions with up to $800,000 ($1.6 million, divided by 2). The balance of their respective death benefits ($450,000), will need to be received as a lump sum to avoid paying excess transfer balance tax.
If the parent had a transfer balance account and they passed away on or after 1 July 2017, the child’s transfer balance cap is their portion of the parent’s retirement phase interest that the child has received as a death benefit pension. A retirement phase interest includes any investment earnings accrued after death but before commencement of the child pension, however, it excludes proceeds from a term life policy.
Therefore, in this scenario, regardless of whether term life insurance is held in accumulation or pension phase, proceeds from the policy will need to be paid to the child as a lump sum.
Kay, aged 61, commenced a pension at age 60, after ceasing work with one of her employers. She kept her main job, and therefore her accumulation account open, to receive her superannuation guarantee contributions and maintain her term life insurance (sum insured $600,000).
Kay dies in January 2018. Her son Jason (age 17), is the sole beneficiary.
On 1 March 2018, when a child pension commences for Jason, the death benefit is paid as follows:
- Child pension $515,000 (Kay’s pension balance plus earnings up to 1 March 2018)
- Lump sum of $50,000 (accumulated super account)
- Lump sum of $600,000 (term life proceeds paid into the accumulated super account).
In this instance, Jason remains under his cap increment, and avoids paying excess transfer balance tax.
While there may be limitations on the proportion of term life proceeds that are payable as a pension, the parent may still choose to fund insurance from, and therefore own cover inside, superannuation.
Advisers should be conscious of the new world in which they are operating. With the superannuation changes already in effect, the landscape has already changed resulting in strategy impacts for both new and existing life insurance recommendations. As term life proceeds may not be fully retainable inside superannuation, advisers should consider where excess proceeds will be invested outside superannuation.
Rachel Leong is the Product Technical Manager for Life Insurance at BT Financial Group