By Julie Steed, Senior Technical Services Manager, Australian Executor Trustees 

(on behalf of firstlinks)

The introduction of the $1.6 million transfer balance cap, effective from July 1 this year, will impact the estate plans of many superannuation members. This article reviews the role of insurance as part of an SMSF’s investment strategy and the changes that people may need to make.

Making insurance part of an SMSF’s investment strategy

Superannuation law requires all SMSF trustees to formulate, regularly review and give effect to an investment strategy relevant to the whole of the fund’s circumstances. The investment strategy must set out the investment objectives of the fund and detail the methods the fund will adopt to achieve these objectives.

When formulating an investment strategy, trustees must consider:

• the risk and likely return of investments
• the diversification of the fund’s investment portfolio
• the liquidity of the fund’s assets
• the fund’s ability to pay benefits and other costs it incurs
• whether the trustee should hold insurance policies for one or more members.

The mandate to consider the insurance needs of members has been law since 2012, but many trustees have not amended their investment strategies to comply with the requirement.

Considering the insurance needs of members generally involves the following steps:

• determining the insurance needs of each SMSF member (including death, total and permanent disability insurance (TPD) and income protection insurance).
• determining whether insurance should be held by the super fund.
• amending the fund’s investment strategy.

Once the insurance needs have been determined, the investment strategy must be updated. Given the personal nature of the assessment of insurance needs, this could be documented by way of a minute, relative to each member.

The notation in the investment strategy can be quite simple and concise, for example:

‘the trustees have considered the insurance needs of members of the fund and have determined that the insurances held by the members within the fund remain appropriate.’

or

‘the trustees have considered the insurance needs of members of the fund and have determined that it remains appropriate for the fund not to hold insurance policies for members.

However, the notation to amend the investment strategy should be supported by more detailed information on the insurance needs and an outline of the reasons the decision were made. This may take the form of a statement of advice (SOA) prepared by an adviser. Trustees need to ensure that the information they retain is sufficient to withstand future scrutiny. For example, the widow of a deceased member who was in an SMSF with his parents may have recourse against the parent trustees if they cannot demonstrate that they considered the insurance needs of all members.

Regular review of investment strategy

Trustees are now required to ensure that the investment strategy is reviewed regularly, to ensure that trustees do not simply ‘set and forget’ their investment goals and insurance needs. Whilst ‘regularly’ is not defined, it is generally considered that at least annually is prudent.

In addition, there are events that should prompt an SMSF trustee to consider a review of the insurance needs of members and the fund’s investment strategy, such as:

• the admittance of a new member
• changes in a member’s personal circumstance (for example, marriage or children)
• a member commencing a pension
• significant changes in financial market conditions.

Insurance and the $1.6 million transfer balance cap

The introduction of the $1.6 million transfer balance cap is likely to prompt a review of holding insurance in super for many SMSF trustees and members of retail superannuation funds.

This is because the transfer balance cap places a limit on the amount of super that can be used to commence a pension that receives tax-free investment returns. On the death of a member, their benefit must be ‘cashed’ and paid to their superannuation dependants (most commonly to a spouse or child). The benefit may be cashed by paying a lump sum benefit, by commencing one or more pensions or a combination of both.

If a death benefit pension is paid, the amount that can be used to start the pension is restricted to the transfer balance cap of $1.6 million. Any amount above the transfer balance cap must leave the superannuation system. Where there are multiple beneficiaries, each beneficiary receives a proportionate share of the transfer balance cap.

If a beneficiary has commenced a pension themselves, their own pension and the death benefit pension they receive counts towards the $1.6 million cap. A member’s own pension may be commuted back to accumulation phase, but a death benefit pension cannot be.

Case study – Margaret

Margaret is a single parent who has two children. She has an accumulation account which holds $400,000 and life insurance of $2 million. She has binding nominations to her two children in equal shares.

If Margaret dies her total superannuation death benefit will be paid 50% to each child ($1.2 million each). Before 1 July 2017, each child could receive $1.2 million as a death benefit pension. However, from 1 July, each child will be limited to a death benefit pension of $800,000 (half of the $1.6 million cap). The remaining $400,000 each must leave the super system as a lump sum payment.

Therefore, it is essential that people with large super balances review their estate plans to ensure any benefits that may be forced out of the super system are directed to structures that can be controlled, such as testamentary trusts established via a will.

The introduction of the super changes is likely to be a catalyst for SMSF trustees to review their insurance needs and for members of other funds to review their own arrangements.