What types of insurance should be held inside an SMSF?

When establishing or managing a self-managed superannuation fund (SMSF), trustees are responsible for making a variety of important decisions, from investment choices to compliance matters. One key area often overlooked is insurance. Understanding what types of insurance should be held inside an SMSF is not only essential for safeguarding the fund’s assets, but also critical for meeting the trustees’ legal obligations under Australian superannuation law.

Insurance plays a crucial role in protecting the financial interests of SMSF members and their beneficiaries. Although super funds are not required to hold insurance policies, SMSF trustees are obligated to consider the insurance needs of members and document that consideration as part of the fund’s investment strategy. This requirement underlines how important insurance is to the overall security and functionality of an SMSF.

This article explores the most relevant types of insurance suitable for SMSFs, how to determine which ones are needed, and the legal and tax implications involved. It will also address how insurance within an SMSF differs from personal policies held outside super and why professional advice is strongly recommended.

The Legal Obligation to Consider Insurance in an SMSF

Superannuation legislation in Australia, specifically the Superannuation Industry (Supervision) Act 1993 (SIS Act), requires SMSF trustees to consider the insurance needs of each member as part of their fund’s investment strategy. Although there’s no requirement to actually purchase insurance, failing to consider it—or failing to document that consideration—can result in a compliance breach.

This requirement means trustees must evaluate which types of insurance are relevant for each fund member. For instance, if a member has dependents and significant debt, life insurance or total and permanent disability (TPD) insurance may be deemed necessary. If a member is self-employed and their income is irregular, income protection insurance may be a more pressing need.

It’s also important to revisit the insurance consideration regularly, especially when a member’s circumstances change. Events such as marriage, having children, purchasing property, or experiencing a health issue should prompt a review of the fund’s insurance position.

Trustees should record all considerations and decisions in the minutes of fund meetings and within the investment strategy itself. This documentation not only ensures compliance but also provides protection in the event of disputes between members or with the ATO.

For more details on trustee obligations, refer to the ATO’s investment strategy requirements, which highlight the importance of considering types of insurance within an SMSF context.

Types of Insurance Commonly Held Inside SMSFs

There are three main types of insurance that are typically considered for inclusion within an SMSF: life insurance, total and permanent disability (TPD) insurance, and income protection insurance. Each serves a unique purpose in protecting fund members and their beneficiaries from financial hardship in the event of unforeseen circumstances.

Life insurance is often the most straightforward to implement. If a member passes away, life insurance ensures that a lump sum is paid to their dependents or nominated beneficiaries. In an SMSF, this benefit is generally distributed as part of the member’s death benefit, and it can help cover debts, living expenses, and education costs for surviving family members.

TPD insurance covers members who become permanently disabled and unable to work again. The claim proceeds can be used to pay off debt, cover medical expenses, and support lifestyle adjustments. While TPD cover can be owned within an SMSF, it must meet specific conditions of release under super law to be considered valid. This can limit its usefulness compared to TPD policies held outside of super.

Income protection insurance is designed to replace a portion of a member’s income if they become temporarily unable to work due to illness or injury. This type of insurance is also available within SMSFs, and premiums are typically tax-deductible to the fund. However, limitations may apply depending on the terms of the policy and the member’s ability to access benefits through the super system.

There are other types of insurance that are not generally held inside an SMSF, such as trauma insurance, which does not satisfy the conditions of release and therefore cannot be effectively structured within the fund. For a comprehensive breakdown of insurable options, Moneysmart’s insurance within super guide provides helpful comparisons.

Tax Implications of Holding Insurance Within an SMSF

Understanding the tax treatment of insurance within an SMSF is essential for ensuring compliance and maximising benefits. Different types of insurance have different tax implications, both in terms of how premiums are treated and how benefits are paid out.

For life and income protection insurance, the premiums paid by the SMSF are generally tax-deductible. This offers a clear advantage compared to holding these policies outside of super, where premium deductibility may be limited or unavailable. These deductions can help reduce the fund’s taxable income and lower the overall tax burden.

However, TPD insurance is more complex. If the policy is held inside an SMSF and structured with “any occupation” definitions (i.e., the member is unable to work in any occupation for which they are reasonably qualified), premiums may be tax-deductible. In contrast, policies with “own occupation” definitions are not typically deductible. Additionally, lump sum TPD benefits paid from the fund may be taxed, depending on the member’s age and the components of their super balance.

Trustees must ensure that the policy terms align with the SIS Act’s conditions of release. If a member becomes entitled to benefits that the fund cannot legally pay out (e.g., trauma insurance), the policy becomes ineffective and may cause compliance issues.

Moreover, benefit payments—especially from life insurance—can carry tax consequences for beneficiaries. For example, if the benefit is paid to a non-dependent (such as an adult child), part of the payment may be subject to tax. To mitigate these risks, trustees should seek tax and legal advice when structuring types of insurance within the SMSF.

For more guidance on insurance and tax in super, the ATO’s guide to insurance in superannuation provides official insights and examples.

Risks and Challenges of Holding Insurance Inside an SMSF

While there are clear advantages to holding insurance within an SMSF, trustees should also be aware of the potential drawbacks. One of the primary challenges is ensuring that the fund’s investment strategy and trust deed allow for these types of insurance. Any oversight in this area could result in compliance issues or invalid policies.

Cash flow can also become a concern. Insurance premiums must be paid from the fund’s available cash or liquid assets. If the SMSF holds mostly illiquid investments like property, it may struggle to meet ongoing insurance costs without selling assets or contributing additional funds—both of which could trigger legal or tax consequences.

Another issue is the potential complexity when managing claims. While policies held outside super often provide faster access to benefits, SMSF-held insurance claims must be assessed in the context of superannuation law. Even if a claim is approved by the insurer, the SMSF must still determine whether the benefit can be legally released based on the member’s condition and policy structure.

There’s also the administrative burden. Trustees must ensure that premium payments are made on time, policy terms remain appropriate, and the documentation is kept up to date. Failing to review these aspects regularly can lead to underinsurance or compliance breaches.

Finally, insurance needs can evolve. What’s suitable for a 35-year-old member may not be suitable at age 60. As such, trustees must conduct periodic reviews of all types of insurance held within the SMSF to ensure ongoing appropriateness.

For SMSFs needing help with structuring insurance or conducting compliance reviews, Insight Perth’s SMSF advisory team can provide tailored support.

When Should Insurance Be Held Outside the SMSF?

Although many types of insurance can be effectively structured within an SMSF, there are scenarios where holding cover outside the fund is more practical. One key example is trauma insurance, which is generally not permitted within super due to its inability to meet a condition of release. Holding such policies personally allows for more flexible access to funds in times of crisis.

In some cases, members may also prefer TPD policies with “own occupation” definitions. These typically provide better protection but are rarely compatible with the legal requirements for SMSF-based insurance. In these instances, it may be preferable to hold the cover separately despite the lack of tax deductibility.

Younger members or those with high income may also benefit from standalone income protection policies that offer greater flexibility and broader coverage. These may come with additional features like partial disability benefits, rehabilitation assistance, or agreed value terms that are not always available through SMSF-structured policies.

The decision to hold insurance inside or outside the SMSF should be based on multiple factors—cost, coverage quality, tax efficiency, and personal preferences. A hybrid approach is often the most effective solution, allowing members to benefit from the tax deductions of SMSF insurance while maintaining additional cover privately.

For those unsure about the right mix, Insight Perth’s business advisory team offers strategic planning services that help SMSFs structure their insurance portfolio efficiently.

Frequently Asked Questions (FAQ)

1. Are trustees legally required to hold insurance in an SMSF?
No, but trustees must consider the insurance needs of each member and document that consideration in the investment strategy. Failure to do so can result in non-compliance with superannuation law.

2. What types of insurance are allowed in an SMSF?
The main types include life insurance, total and permanent disability (TPD), and income protection. Trauma insurance and other non-conforming covers are generally not permitted.

3. Are insurance premiums tax-deductible in an SMSF?
Yes, life and income protection insurance premiums are usually tax-deductible to the fund. TPD premiums may be deductible depending on how the policy is structured.

4. Can an SMSF pay out an insurance benefit directly to a member?
Only if the benefit meets a superannuation condition of release. For example, life insurance can be paid out upon death, and TPD can be paid if the member is permanently disabled according to super law.

5. Should I hold some insurance outside my SMSF?
In some cases, yes. Policies like trauma or TPD with “own occupation” definitions may offer more flexible benefits outside of super. A financial adviser can help determine the best arrangement.

Conclusion: Choosing the Right Types of Insurance for Your SMSF

Selecting the right types of insurance to hold within your SMSF is a critical part of protecting your retirement savings and ensuring the well-being of fund members. While life, TPD, and income protection insurance can offer substantial benefits and tax advantages, they also come with strict compliance obligations and legal limitations.

Trustees must evaluate each member’s needs, review policy structures, and ensure their fund’s investment strategy supports the inclusion of insurance. Periodic reviews are essential to maintaining relevance and compliance as life circumstances evolve.

With the right strategy and professional guidance, insurance inside an SMSF can be a powerful tool that complements your overall retirement planning. If you’re unsure where to start, reach out to Insight Perth’s tax and accounting specialists to help you get it right.