Traps for SMSF members who keep money in a big fund for insurance
By Gary Chau (gchau@dbalawyers.com.au), Lawyer, David Oon, Lawyer (doon@dbalawyers.com.au) and Bryce Figot (bfigot@dbalawyers.com.au), Director, DBA Lawyers
A desire for some people who exit large funds and start a new SMSF is to leave a portion of their superannuation in the large fund. This is often because it can be relatively simple to retain life, total and permanent disability (‘TPD’) and income protection insurance cover in a large fund.
While the above strategy broadly works, SMSF members need to be careful of traps in large funds that can cause a loss of cover. This article highlights some of the traps and pitfalls to look out for.
Keeping money in a big super fund
One of the perceived advantages in keeping a balance with a large superannuation fund is access to low cost insurance that has been arranged ‘in bulk’ by the superannuation fund. Often, no medical examinations are necessary to have access to this cover.
Despite any advantages, there can be terms in these insurance arrangements that cause cover to cease. This could be unexpected. Some of the circumstances we are aware of are outlined below.
No employer contributions
At a super fund known to us, if employer contributions cease for six months, a member automatically loses income protection cover. We understand that this is a policy for certain large funds that offer members automatic income protection insurance. In this vein, we are also aware of another large fund where income protection cover ceases after 13 months from the date of the last employer contribution, regardless of account balance. After 12 months (one month before the 13 month period expires), the fund notifies the member that cover is about to cease.
Not meeting minimum balance requirements
To retain cover at most large funds, the funds usually require that the member maintains a minimum balance in your account. From a review of a number of funds, this can be as low as $1,000 or as high as $10,000. While most large funds let members retain cover as long as premiums can be automatically deducted from their account, we are aware of a fund that will cease insurance cover for life, TPD and income protection when the account balance falls below $1,500 and no employer contributions are made after 12 months. This fund will contact the member to advise that cover will cease. Similarly, we are aware of other funds, including a fund that will cease life, TPD and income protection cover if the member’s account balance is below $2,000 and no employer contributions or rollovers are made for 12 consecutive months. Another fund will cease life and TPD cover six months from the end of the month from which the employer made a contribution to the member’s account and their balance is less than $1,200.
No longer working for a particular employer
Further, we are aware of a fund that requires that a particular employer (among a group of approved employers) makes contributions to the member account. At this fund, TPD and income protection cover cease without notice if the member is no longer working for that employer after 71 days and their account balance is less than $3,000.
No longer working in the corporate body or public sector
Some large funds cease insurance cover if the member no longer works with a particular employer or in a particular industry. This is a common feature of corporate and public sector superannuation funds. We are aware of some public sector funds where income protection cover ceases on the day the member officially ceases employment with the relevant public sector. There is also another public sector fund that will cease all cover after 60 days from the last employer contribution or when the member stops working in the relevant public sector. Additionally, these public sector funds generally do not accept further contributions or rollovers if the member is no longer working for the relevant public sector employer.
Membership in most corporate funds is for employees and former employees, and at certain funds this is extended to allow relatives of employees to join. We are aware of a corporate fund that automatically provides employees a corporate cover that would not otherwise be available to non-employees. However, membership at this corporate cover is only available to current employees. Hence, if the member stops working with the relevant employer connected to this corporate fund and does not have a minimum $1,200 balance with the fund, the corporate cover which includes life, TPD and income protection cover will cease 30 days after the member ceases employment.
Restrictions on terminal illness payouts
We are also aware of a certain fund whereby on terminal illness, the insurance can pay out at the TPD level (or a deemed TPD level), which could be lower than the amount of life cover. This payment reduces any remaining life cover paid on death. The effect of this may be a deprivation of funds to pay for medical or palliative care before death. This method of terminal illness cover stands in contrast to other funds that pay out 100% of life cover upon terminal illness.
This style of cover can also give rise to more tax because the beneficiaries will receive the death benefits, as opposed to the member receiving benefits before they die.
Staying informed
Be aware that some large funds may not give warning when insurance cover is about to cease. Therefore it is important to monitor accounts periodically.
Large super funds should have their insurance policies outlined in their insurance guide or product disclosure statement. These policies should be read carefully and any questions should be directed to the super fund for clarification on exactly how insurance cover applies.
Insurance in an SMSF
If the member no longer wishes to maintain insurance in a large super fund, or is unable to, it is of course possible to maintain certain kinds of insurance in an SMSF. Indeed, the law says that SMSF trustees must formulate, review regularly and give effect to an investment strategy that includes consideration of whether to hold a contract of insurance for one or more members of the fund.
This article is for general information only and should not be relied upon without first seeking advice from an appropriately qualified professional.
Note: DBA Lawyers hold SMSF CPD training at venues all around Australia and online. For more details or to register, visit www.dbanetwork.com.au or call 03 9092 9400.
The article is used with the permission of DBA Lawyers, Level 1, 290 Coventry Street
South Melbourne Vic 3205
10 March 2016
