Self preservation
How to protect your wealth and income.
Many high income earners rely significantly on their salary to meet their everyday living expenses, pay their mortgage and fund their investments.
What this also means is they’re leaving themselves unprotected should unforeseen circumstances, such as an illness or injury, prevent them from working.
Unless you have significant net wealth and/or derive a large proportion of your income from passive sources (such as investments) it makes sense to protect your income, rather than relying on self-insurance as an effective strategy.
Protecting your income
“Those with higher average incomes, often have larger lending levels too,” says Jon de Fries, MLC’s National Manager of Insurance Strategy. “The impact of losing their main household income could have a devastating impact on their ability to service this debt as well as maintain their lifestyle.”
Unfortunately, many high income earners are unaware of the dangers of self-insuring. Even if you’re in a strong net asset position, self-insuring can be risky for a number of reasons:
• your assets may be illiquid
• you could be forced to sell during adverse market conditions
• significant exiting costs (including capital gains tax) could be payable, and
• longer-term wealth creation plans could be undermined.
In the past, high income earners may have been unable to insure their salary effectively due to restrictions on the maximum possible income protection (IP) claim benefit.
However, some life insurance companies have recognised the needs of this group, and it’s now possible to receive a benefit significantly higher than industry standards.
“What the changes to IP insurance mean is that high income earners who may have previously considered taking up cover, but decided against it due to not being able to protect enough of their salary, can now have the flexibility to take out greater protection where needed,” says Mr de Fries.
“And even where some degree of self-insurance may be a viable option, clients may want to use IP insurance and reduce the premium cost by selecting a longer waiting period or shorter benefit payment period.”
Super versus self-ownership
IP insurance can either be self-owned, or owned by the trustees of a super fund.
“If you’re eligible to claim your super contributions as a tax deduction or make salary sacrifice contributions, the after-tax cost of IP insurance inside super will generally be the same as self-ownership,” says Mr de Fries.
And even though the insurance is owned by the trustees of the super fund, the benefits are still assessable to the life insured for tax purposes.
“However, you should keep in mind these super contributions will count towards the concessional cap1, regardless of whether they’re used to purchase investments or insurance,” warns Mr de Fries.
As a result, higher income clients with sufficient surplus cash flow may be better off using up the concessional contribution cap for investment purposes or funding life and TPD insurance premiums. This is because there are tax incentives for using CCs for these purposes that are generally not available outside super.
But regardless of the concessional contribution cap implications, taking out IP insurance in super can offer some other benefits; particularly when purchased by the trustees of a self-managed super fund.
“A great example is that for clients aged 55 or over, any claim proceeds could be used to pay a transition to retirement pension where a 15% tax offset is available to age 59 and no tax is payable at age 60 or over,” says Mr de Fries.
“Furthermore, regardless of the client’s age, the claim proceeds could be retained in the concessionally taxed super environment with a greater degree of asset protection.”
Company and discretionary trust ownership
Another option is for the IP policy to be owned by a company or the trustees of a discretionary family trust used to carry on a business, where the business pays the premiums to provide a salary continuance benefit for its employees.
“In this scenario, the premiums are generally deductible to the business and the benefits are ultimately assessable to the employee,” says Mr de Fries.
Employees can include principals and other people who receive a salary, wage, employer super contribution or reportable fringe benefit from the business.
However, this doesn’t include people who are purely reimbursed by company dividends or trust distributions.
Alternatively, an employee can own an IP policy and the business can pay the premiums as a fringe benefit for the employee.
“In this situation, the business can claim the premiums as a tax deduction,” says Mr de Fries. “The benefits will then be assessable to the employee and, because the premiums are ‘otherwise deductible’ to the employee, the business is not liable for fringe benefits tax.
” However, it’s worth keeping in mind that if the company or discretionary trust owns the IP policy and another party (such as a company shareholder or trust beneficiary) pays the premiums, the premiums would generally not be personally deductible to the other party.
Expert advice
What’s clear is whichever way you structure it, there are now a number of options for obtaining adequate IP insurance for high income earners.
However Mr de Fries urges the benefits of getting good advice to maximise the potential benefits.
“This is a complex area but one that if structured correctly can net significant advantages,” he says. “With this in mind, clients should seek advice before making any decisions regarding the ownership of insurance policies.”
1 The concessional contribution cap is $25,000 per annum.