Insurance cover Protecting your family and assets January 2012

Insurance coverProtecting your family and

assets January 2012

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The agenda

1. The importance of insurance

2. The different types of insurance and their benefits

3. Ownership options

4. Taxation consequences

5. Insurance through a super fund

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The agenda






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Why is insurance important?

How will your family cope without you?

Insurance is important because if death or disability occurs, your family and/or dependants are provided with funds to help:

– continue their current standard of living (including servicing existing debt) and

– pay medical or funeral bills

If a serious injury occurs, could you pay for hospital costs, ongoing treatment, time off work and living costs for you and your family until you recover, if you fully recover.

Ideally, you will have planned to help ensure there is enough cover to cope with these situations.

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The agenda






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Types of Insurances for total protection

Life Insurance

Terminal Illness

Total and Permanent Disability (TPD)

Trauma

Income Protection

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Life insurance

Pays a benefit in the event of death.

The benefit is usually in the form of a lump sum.

Referred to as either Term Life/Whole of Life/Endowment.

Term Life cover is the popular form of life insurance.

There are some situations where benefits are not paid. (e.g. suicide within 13 months of policy commencement is a common one).

Often purchased with other insurances as ‘riders’.

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Life insurance – Sam and Susan case study

Sam and Susan have 3 children, all of school age.

Susan works part-time as a physiotherapist.

They have a mortgage of $300,000

Sam took out 2 years earlier a life insurance cover of $500,000.

Whilst driving home from work one night, a major accident on the freeway resulted in a four car pile up.

Unfortunately for Susan, Sam was killed in the collision.

The insurance proceeds helped pay off the mortgage with enough left over for investment to cover the children’s future school fees.

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Terminal illness

Terminal illness means a sickness or injury which is expected to result in death within 12 months.

A terminal illness benefit is usually purchased as part of a life insurance policy.

The policy will pay a lump sum benefit, equal to the amount of the Death Benefit at that time if the insured person suffers a terminal illness.

This benefit provides funds that can be received prior to death when a family requires funds for whatever reasons (e.g. funeral expenses).

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Total and permanent disability

Pays a benefit in the event of Total and Permanent Disablement (TPD).

The benefit is usually in the form of a lump sum and is received when the insurers definition of TPD is satisfied.

It is important to be aware of the definition of TPD that applies under the policy as each product provider has their own definition.

The two main definitions of total and permanent disability:

– Own occupation TPD

– Any occupation TPD

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TPD – the definitions

(a) for any occupation

A person has suffered a sickness or injury which has prevented them from working and is [likely to prevent them from ever] again being able to work in any occupation for which they are reasonably qualified because of education, training or experience which would pay at a rate greater than 25% of their earnings in the last 12 months.

(b) for own occupation

A person has sickness or injury which has prevented the Insured Person from working and the sickness or injury is likely to prevent the Insured Person [from ever again being able to work] in their own occupation.

Note (b) is a narrower definition

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A TPD case study – Sam and Susan

In this case study Sam survived the accident but is now a paraplegic.

Sam’s insurance cover included “own occupation” definition for the TPD benefit.

As Sam worked as an ambulance officer he can no longer drive the ambulance vehicle or assist with manual handling of patients.

Sam submits an insurance claim and as he can no longer do his job, he is paid out the sum insured lump sum applicable to the TPD benefit.

He now intends to seek professional advice from a financial planner on how best to invest the proceeds.

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Trauma insurance

Trauma insurance pays a benefit if a person suffers from one of a range of specific medical events (depending on the product provider)

Some examples are below:Cancer Heart attack

Open heart surgery BlindnessAdvanced diabetes Bacterial meningitis

Benign brain tumour Loss of hearingLoss of independent living Loss of limbs

Loss of speech Multiple sclerosisMuscular dystrophy Parkinson’s disease

Coma Major head traumaParalysis Severe rheumatoid arthritis

It is important that the full definition of the medical event is met in order to qualify for a benefit. Note that some of these conditions may be covered under a TPD benefit if the TPD definition is satisfied.

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Income protection / salary continuance

Income protection provides a regular monthly income to a person who disabled is unable to work because of sickness or injury.

Depending on the product provider, you can receive 70% - 80% of regular monthly earnings in the event of sickness or injury.

There may be maximum monthly benefits for which you can insure.

Monthly benefits paid may be reduced or offset by other payments you receive because of your sickness or injury.

Note this insurance is associated with working as it seeks to preserve a large part of your income should something unfortunate and unexpected occur. Some providers will continue to provide cover if unemployment occurs.

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You can receive a total disability benefit - monthly benefit if you are totally disabled because of sickness or injury and unable to work OR

A partial disability benefit if you are on reduced duties and earning less than before your disability.

There are waiting periods involved with this insurance, usually 30, 60, or 90 days before benefit is paid.

Benefits are paid monthly in arrears by some providers which means you may have to wait a further 30 days to receive any money.

If you choose a longer waiting period, you need to ensure that you have enough of your own funds to cover this period. This period could be covered by sick leave, annual leave or long service leave.

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Partial disability and partially disabled means:

The insured person is working and is able to perform one or more of the important income producing duties of their usual occupation, but is unable to perform all of them or

The insured is working and is able to perform all of the important income producing duties of their usual occupation, but in a reduced capacity or is working in another occupation.

Total disability and totally disabled means:

The insured person is, because of sickness or injury:

– Unable to perform any occupation for which they are reasonably suited by education, training or experience and

– Not working and under the regular care of a doctor.

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Income protection / salary continuance - case study

Matt is a 35 year old married man with two young children.

He works as a foreman on a construction site and earns $75,000 a year or $6,250 a month.

Matt has a mortgage on the family home and has been worried about his family’s ability to cope should something happen to him. Matt decides to take out income protection.

A few years later, Matt is diagnosed with a blood vessel malformation that put pressure on the lower spinal nerves and reduced his mobility. He required surgery and physiotherapy as well as a long period off work for rehabilitation.

After waiting the 30 day waiting period, Matt receives $4,687.50 (75% of $6,250 per month) which allows him to continue his mortgage payments and meet daily living expenses.

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Insurances worth considering – points to note

Premiums are the price you pay for insurance.

They vary with age, smoker status, pre-existing conditions and occupations.

Frequency of payment depends of the product provider but is often monthly or annually.

The Sum insured is the amount of benefit you receive should an insurable event occur.

Always be aware of the exceptions to any policy you purchase so that you are not caught out when you or your family really needs the funds.

Often you can choose to index your sum insured with inflation to keep abreast of rising costs.

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Insurances worth considering – points to note

Be familiar with the insurance definitions you sign up for. For example, in Sam’s case, had he purchased TPD under the “any occupation” definition (instead of own), he may not have been eligible for a benefit had he previously worked as a call centre operator for the hospital.

Always regularly review your insurance arrangements so that you have enough cover.

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The agenda






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Ownership of the insurance policy

Up to 3 people (or entities) can have an interest in a personal life insurance policy:

1. The owner of the policy

2. The life insured on the policy

3. The nominated beneficiaries

Where beneficiaries are chosen, the life insurance company must pay to those nominated.

By nominating a beneficiary, possible delays of obtaining probate and administering the estate can be avoided. It can also mean a claim can be processed more efficiently than if no nomination was made.

A benefit paid to a nominated beneficiary bypasses the deceased estate.

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Ownership options

Making the ownership decision upfront will determine:

– Who controls the policy

– Long term relevance

– Whether intended tax, estate planning and asset protection results are achieved.

Ownership could be an individual/company or even a trust (e.g. Super Fund).

Each ownership structure has advantages and disadvantages so seeking advice is important.

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Self ownership

The life insured owns the policy and controls the operation of the policy.

The life insured or their estate receives the proceeds unless a beneficiary is chosen.

So in Sam and Susan’s case, Sam owned the policy, Sam was the life insured and Susan was nominated as beneficiary.

Popular because the owner can make changes to the policy if circumstances change, for example increasing and decreasing sum insured.

Easy to nominate and revoke beneficiaries, especially where ex-spouse involved.

On the downside, beneficiaries may be kept in the dark with regard to any changes made.

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Cross ownership

The policy is owned and proceeds paid to someone OTHER THAN the life insured.

Popular among spouses and business partners and employers on behalf of employees.

So again in Sam and Susan’s case, Susan could have owned the policy with Sam being the life insured . As the owner, Susan may receive the proceeds unless she nominates a beneficiary.

Additionally, Sam would own a policy on Susan’s life so he would receive the proceeds should anything happen to her.

Important: Avoids costs associated with probate as the benefits are not paid through the estate.

On the downside, in the case of a break-up, may need to purchase a new policy as difficult to adjust a policy that belongs to someone else.

May be difficult to purchase a new policy based on age, health status, occupation and more expensive.

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Other ownership arrangements

Joint-ownership

The policy is owned as joint tenants, if one owner dies, the remaining owner assumes the deceased’s ownership of the policy (avoids estate).

Insurance through Superannuation

Trustee of the Super fund owns the insurance policy, more about this later.

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The agenda






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Tax consequences – life insurance / terminal illness

Owned* by Paid byDeductible

?

Are benefits taxable?

Are benefits subject to

CGT?

Life insured Life Insured No No No

Other

individualOther individual or life insured

No No No

Life insured Employer Yes, but

FBT No No

* Original beneficial owner or acquire policy for no consideration

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Tax consequences – TPD / trauma

Owned by Paid byDeductible

?



CGT?

Life insured Life Insured No No Yes*/No

Other

individualOther individual or life insured

No No Yes*/No

Life insured Employer Yes, but

FBT No Yes*/No

* Capital Gains Tax is payable if payments are made to someone other than the insured person or their relative/spouse

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Tax consequences – income protection

Owned by Paid byDeductible

?



CGT?

Life insured Life Insured Yes Yes* No

Life insured Employer Yes, to

employerYes, to

employee No

* Pay-as-you-go tax is deducted from the monthly payments

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The agenda






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Super Fund$$$

Contributions from member

Benefits to member/SIS dependants/LPR

$$$

Premiums to insurer

$$$

Claim proceeds from

insurer

Insurance Policy

Life insured = Member

Owner = Trustee

Choosing insurance through Super

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Choosing insurance through super

The premium is an expense of the fund.

Premiums are tax deductible to the member.

Insurance proceeds are paid to the trustee.

Proceeds are paid to members according to Super rules.

SUPER LAW – determines who gets the benefit.

TAX LAW – determines how the benefit is taxable.

Member can nominate beneficiaries to receive benefit as long as they are dependants or estate.

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Insurance outside or inside Super ?

John aged 36

Marginal tax rate 38.5% (including Medicare levy)

Has $700 pre tax salary to purchase life & TPD insurance cover

Non-smoker

TPFD class 1

Stepped premium quote required

What cover can he purchase ?

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Inside or outside super ?

Insurance outside Super

Insurance in Super

Pre-tax salary available to purchase insurance

$700 $700

Less tax @38.5% ($269.50) (n/a)

Net premium available $430.50 $700

Sample life & TPD cover purchased

$352,000 $573,000

Sample additional insurance cover purchased

$221,000

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Choosing insurance through super

Trustees can only pay to dependants.

Super law defines who a dependant is.

In the extreme case where there are no dependants, a Trustee can pay to a non-dependant.

Tax law also relies on the definition of dependant to determine how a benefit is taxed.

So who is a dependant for Super and tax purposes?

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SIS dependant?

Tax dependant?

Death benefit income stream

option?

Spouse Yes Yes Yes

De facto/same sex spouse Yes Yes Yes

Former spouse No1 Yes No

1. Unless financially dependant on the deceased

Definition of a dependant

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SIS dependant?

Tax dependant?


option?

Child under age 18

Yes Yes Yes1

Child under 25 and financially

dependantYes Yes Yes1

‘Disabled’ child of any age2

Yes Yes Yes

Other child Yes No3 No

1. Must be commuted at age 25

2. As per the definition in the Disability Services Act 1986

3. Unless ‘financially dependant’

Definition of a dependant - children

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Other dependants

SIS dependant?

Tax dependant?


option?

Financial Dependant

Yes Yes Yes

Interdependant Yes Yes Yes

Estate Yes Yes/No1 No

1. Depends on the ultimate beneficiary

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Insurance through super – death benefits payments

In the event of death, proceeds paid to Trustee.

Death is a compulsory cashing event.

Insurance proceeds plus account balance paid to dependants are tax free.

Taxable component is taxable if paid to non-dependants e.g adult children.

Where no nomination of beneficiaries has been made, trustee decides who gets the benefit.

Super account balance plus insurance does not form part of the estate unless member nominates the estate or Trustee decides to pay to estate.

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Insurance through super – tax treatment of death benefits paid as a lump sum

Paid to dependants Paid To non-tax dependants

– All Tax free including from untaxed sources

– Tax free component tax free

– Taxable component

Taxed element max 15%*

Untaxed element max 30%*

* Plus Medicare levy – unless via estate

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Choosing insurance through super – tax treatment of death benefits paid as an income stream

* From taxed source

** Plus Medicare levy

Income Stream/Pension*

– Tax free if deceased or dependant 60 or over

– If both less than 60: Tax free component tax free Taxable component at MTR** less 15% tax offset up to age 60

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Insurance through super – payment of TPD benefits

In the event of total and permanent disability, proceeds paid to Trustee after the insurer’s definition of TPD is satisfied.

TPD is NOT a compulsory cashing event, Permanent incapacity definition in Super law must be satisfied.

Permanent incapacity – member is suffering from ill health (whether physical or mental), and “the trustee is reasonably satisfied that the member is unlikely, because of the ill-health, to engage in gainful employment for which the member is reasonably qualified by education, training, or experience”.

Super fund trustees are ‘reasonably satisfied’ if the client submits 2 medical certificates containing the above statement (or words to this effect).

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Insurance through super – payment of TPD benefits

Insurance proceeds plus account balance can be paid to the member if they meet the ‘permanent incapacity’ condition.

If definition not satisfied, proceeds remain trapped in the fund under the Super preservation rules until:

– Member retires

– Dies, or

– Satisfies another condition of release

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Insurance through super – tax treatment of TPD benefits

A calculation occurs once the benefit is payable to the member as a lump sum.

The aim is to increase the tax free amount in line with a future service component which could have been achieved had the member continued working until retirement age.

The tax free amount resulting from the above formula is added to any tax free component already in the Super account.

The benefit is then taxed as follows:

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Insurance through super – tax treatment of TPD benefits

Taxable component received as a lump sum

Age Superannuation lump sum*

60 and over NIL

Preservation age – Age 55 - 59

First $165,0001 NIL

Amounts over $165,0001

16.5%2

Below preservation age

21.5%2

* Tax rates stated are maximum rates of tax

1 Refered to as the low rate cap, indexed annually, but only increased in increments of $5,000

2 Including Medicare levy

* Tax rates stated are maximum rates of tax

1 Refered to as the low rate cap, indexed annually, but only increased in increments of $5,000

2 Including Medicare levy

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Choosing insurance through super – tax treatment of TPD benefits – case study

Bernie Williams suffers a TPD event at age 35.

TPD insurance inside superannuation is $500,000

His Super account balance is currently $100,000

($10,000 tax free, $90,000 taxable).

His total benefit to be paid $600,000

How much tax will he pay if he withdraws the whole amount?

Tax free amount from invalidity formula:$400,000 + $10,000 (existing tax-free) = $410,000

Therefore taxable portion: $600,000 - $410,000 = $190,000

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Tax on TPD benefits – case study

Component Tax

Tax Free $410,000 Nil

Taxable $190,000($190,000 @ 21.5%*)

$40,850

* 21.5% tax rate as Bernie under his preservation age

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Insurance through super – income protection benefits

To receive an income stream benefit while a member is temporarily disabled, they need to satisfy 2 definitions:

– Similar to a TPD benefit, the insurers definition of partial or total disability has to be satisfied, this permits payment to the Super fund

– The member must satisfy the temporary incapacity definition under the Super rules:

temporary incapacity, in relation to a member who has ceased to be gainfully employed (including a member who has ceased temporarily to receive any gain or reward under a continuing arrangement for the member to be gainfully employed), means ill-health (whether physical or mental) that caused the member to cease to be gainfully employed but does not constitute permanent incapacity.

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Choosing insurance through super – tax treatment of income protection benefits

Premiums are claimed by the trustee as an expense of the fund.

Income Protection benefits received by the member are taxed at your marginal tax rates, like salary or wages.

The same as tax treatment inside and outside of Super.

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In summary

Insurance is an important part of a financial plan.

It is important to choose the right type of insurance.

It is important to choose the right amount of insurance.

Seeking advice will assist you to make the appropriate decisions and safeguard your family again unforeseen events.

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Asgard Capital Management Limited ABN 009 279 592, AFSL 240695 (Asgard). Information current as at 1 January 2012. This publication provides an overview or summary only and it should not be considered a comprehensive statement on any matter or relied upon as such. This presentation contains general information only and does not take into account your personal objectives, financial situation or needs. You should therefore consider whether information or advice contained in this presentation is appropriate to you having regard to these factors before acting on it. You should seek personalised advice from a financial adviser and your accountant before making any financial decision in relation to matters discussed in this presentation. The taxation position described is a general statement and should only be used as a guide. It does not constitute tax advice and is based on current tax laws and our interpretation. Your individual situation may differ and you should seek independent professional tax advice. Consider our disclosure documents which include our Financial Services Guide available on www.asgard.com.au. © Asgard Capital Management Limited 2012.

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Insurance cover Protecting your family and assets January 2012