‘Simpler super’ charges up tax bills on life insurance
The new super rules have rendered employer-provided life insurance plans nowhere near as friendly as they previously were. And a new $140,000 tax-free cap is vastly inadequate.
Despite the many benefits of the “simpler super” regime, among the casualties has been employees who receive personal insurance protection from their employer. (Employers often provide subsided group insurance policies, or negotiate discounts for employees with their greater buying power.)
Employees in these arrangements may be hit by the new tax rules applying to death benefit employment termination payments — to the point that many employees and their families could have their insurance eroded by high tax penalties.
The change is a result of the Federal Government removing employer-provided termination payments from the super regime, and introducing a less favourable regime for taxing all employer-provided payments (including insurance benefits). The industry had been lobbying for consistent treatment of super and employer-provided insurance benefits, but, to date, without luck.
Problems off the plan
The problem arises when an employer provides a group insurance plan for employees, and an employee member dies, producing a life insurance claim under. The tax treatment depends on whether the proceeds from the life policy are to be passed to a dependant or non-dependant, and what components are paid out.
Any tax-free component remains tax free regardless of whether it is destined for a dependant or non-dependant (although this component would arise only in limited cases).
However when it comes to the taxable component it’s different. This, when paid to dependants, will remain tax free up to the employment termination payment cap of $140,000. Any amount of taxable component over this cap will be taxed at the highest marginal tax rate. As many employees are asking for higher levels of life cover through their employer, this is a growing concern.
Bad fit for mortgages
However the position is worse for non-dependants receiving the proceeds. The taxable component will be taxed at 30% for amounts up to the employment termination payment of $140,000 — but any amount of taxable component above will be taxed at the highest marginal tax rate.
With average mortgages now in excess of $200,000 — and up to $350,000 in some areas — $140,000 will not go very far. It’s not clear why the $140,000 cap was imposed, because it clearly does not provide enough support for families.
Its inadequacy is further highlighted in looking at the underinsurance gap. It is not only the difference between asset and liabilities, but is more accurately a message of the differences between maintaining current lifestyle and a significantly reduce lifestyle.
Even if the $140,000 did clear the mortgage, it could still leave the deceased’s family struggling to pay for other essentials, such as living expenses, car payments or school fees.
These new rules are much less generous than the previous rules, which were linked to the reasonable benefits limit (RBL). This vanished with the new “simple super” regime.
Mounting tax
Under the previous rules, when a death benefits temination payment was paid to a dependant it was tax free up to the deceased person’s pension RBL ($1,356,291 for the 2006-07 financial year).
For a non-dependant, the payout was taxed at a maximum of 30% up to the deceased person’s pension RBL, with only 5% of the pre-July 1983 component taxed at the marginal rate.
Any amount over the RBL (whether being paid to a dependant or non-dependant), was taxed at up to the top marginal tax rate. To compare the previous and current rules, the top marginal tax rate didn’t previously kick in until about $1.3 million — compared with the $140,000 cap from July 2008.
When an employer provides total and permanent disability insurance for their employees, via a group insurance arrangement outside of super, the tax can also mount up, depending on the amount of cover, if the employee is eligible for a larger tax-free component from invalidity and their age.
From July 1, any invalidity or pre-July 1983 amounts in a life benefit employment termination payment will be tax free as they will form part of the tax-free component.
The remaining benefit will be a taxable component, and thus taxed differently depending on the amount paid and the employee’s age.
Reassess your situation
As a result of these super changes, many employers and employees alike may need to rethink their insurance arrangements.
For the time being, for employers and employees it may be a case of simply paying to incur a future tax liability. Unless the rules changes, it may be more appropriate to have life insurance cover placed within super rather than owned by the employer.
Employers considering a change to super-provided insurance benefits for employees need to consider issues such as level of cover, additional premiums, administrative and compliance costs.
Source: Tower Australia
Tags: Insurance, Superannuation