Income Protection: Inside or Outside Super?

Income protection insurance is a crucial financial safety net for many Australians, offering coverage if you become unable to work due to illness or injury. One common decision policyholders face is whether to hold their income protection insurance inside their superannuation fund (super) or outside of it. Both options have their pros and cons, and the right choice depends on individual circumstances and preferences. In this guide, we'll explore the key considerations and differences between holding income protection inside versus outside of super.

What is Income Protection Insurance?

Income protection insurance provides a regular income if you are unable to work due to a covered illness or injury. Typically, it replaces up to 75% of your pre-tax income and can cover you for a specific period, such as two years or until you reach retirement age, depending on the policy terms. The premium for this insurance can be paid through various means, including out of pocket or through superannuation.

Income Protection Inside Superannuation

Premium Payments

When income protection insurance is held inside super, the premiums are paid from your superannuation fund. This approach can be beneficial for several reasons:

• Tax Efficiency: Premiums paid from superannuation are tax-deductible to the fund, which can potentially reduce your overall tax liability.
• Reduced Out-of-Pocket Costs: Since premiums are deducted from your superannuation balance, there’s no immediate impact on your personal cash flow.

Benefits

• Tax Advantages: Contributions to super are taxed at a concessional rate (usually 15%), which is lower than most individual tax rates. This can make paying for insurance through super more cost-effective.
• Ease of Payment: Premiums are automatically deducted from your super balance, simplifying the payment process.

Drawbacks

• Impact on Retirement Savings: Premiums paid from super reduce your retirement savings. Over time, this can significantly impact your superannuation balance, especially if you claim frequently or have high premiums.
• Policy Limitations: Income protection policies within super might have different terms and conditions compared to those purchased outside super. Coverage might be less comprehensive, and there may be restrictions or exclusions.
• Complex Claims Process: If you need to claim, it might involve additional administrative steps, as your superannuation fund will be involved in managing the claim process.

Suitability

Income protection insurance inside super might be suitable for those who:

• Prefer to manage insurance premiums through their superannuation balance.
• Are looking for potential tax benefits.
• Are okay with potential reductions in their superannuation balance.

Income Protection Outside Superannuation

Premium Payments

When income protection insurance is held outside super, you pay premiums directly from your personal funds. This approach has its own set of advantages and disadvantages:

• Direct Control: You have complete control over how and when you pay your premiums, and there’s no impact on your super balance.

Benefits

• Comprehensive Coverage: Policies purchased outside super often provide more flexibility and may offer better coverage options compared to those within superannuation. You can choose policies that best fit your needs without superannuation restrictions.
• No Impact on Retirement Savings: Paying premiums from your personal funds means your superannuation balance remains unaffected. This can be particularly important if you are close to retirement age or have a substantial super balance.

Drawbacks

• Higher Personal Costs: Premiums paid outside super are not tax-deductible (unless you are self-employed and meet certain conditions), which means you might end up paying more from your personal funds.
• Less Tax Efficiency: Without the tax concessions available through superannuation, the cost of premiums might be higher.

Suitability

Income protection insurance outside super might be more suitable for those who:

• Prefer a more tailored policy with potentially better coverage.
• Want to avoid reducing their superannuation balance.
• Are willing to pay the premiums from their personal funds without tax benefits.

Key Considerations

Coverage and Flexibility

Policies outside super generally offer more flexibility and comprehensive coverage options. It’s important to review policy details to ensure it meets your specific needs, including benefits, exclusions, and waiting periods.

Tax Implications

Consider the tax implications of both options. Premiums paid from superannuation can be tax-deductible to the fund, potentially reducing your taxable income. However, premiums paid outside super do not have this advantage, although you avoid reducing your retirement savings.

Impact on Retirement Savings

Holding income protection insurance inside super will reduce your superannuation balance. This reduction might impact your retirement savings, especially if premiums are high or if you make frequent claims. Calculate how this might affect your long-term retirement goals.

Claim Process

Understand how claims are processed for both inside and outside super policies. Policies inside super might involve additional administrative steps due to the involvement of your super fund.

FAQs

What is the main difference between holding income protection insurance inside super and outside super?

The main difference lies in how premiums are paid and their impact on your finances:

• Inside Super: Premiums are paid from your superannuation balance, which may offer tax advantages but can reduce your retirement savings.
• Outside Super: Premiums are paid from your personal funds, potentially offering more comprehensive coverage without impacting your super balance.

Are premiums for income protection insurance inside super tax-deductible?

Yes, premiums paid from your superannuation fund are typically tax-deductible to the fund, which can reduce your overall tax liability. This tax advantage is not available for premiums paid outside of superannuation.

Can I have income protection insurance both inside and outside superannuation?

Yes, you can hold income protection insurance both inside and outside superannuation. It’s important to manage both policies to ensure they provide adequate and non-overlapping coverage.

What impact does holding income protection insurance inside super have on my retirement savings?

Premiums paid from your superannuation reduce your super balance. Over time, this can significantly impact your retirement savings, especially if you have high premiums or make frequent claims.

Are policies held inside superannuation less comprehensive than those held outside?

Income protection policies inside super might have different terms and conditions compared to those purchased outside super. They may offer less flexibility or have more restrictions. It’s important to review the policy details to ensure it meets your needs.

What should I consider when deciding whether to hold income protection insurance inside or outside super?

Consider factors such as:

• Cost of Premiums: Tax implications and out-of-pocket costs.
• Coverage Options: Flexibility and comprehensiveness of the policy.
• Impact on Superannuation: How premiums might affect your retirement savings.
• Claim Process: Administrative steps and potential delays.

How do I transfer income protection insurance from super to a personal policy?

To transfer your insurance from super to a personal policy, contact your insurer and superannuation fund. They can guide you through the process and explain any potential impacts on your coverage and premiums.

Can I adjust my income protection insurance policy after purchasing it?

Yes, you can typically adjust your policy after purchase. This may include changing coverage levels or switching between policies inside and outside super. Contact your insurer to discuss any desired changes and their implications.

Are there any specific considerations for self-employed individuals regarding income protection insurance?

Self-employed individuals can often claim premiums paid outside super as a tax deduction, which may make this option more attractive. It’s advisable to consult with a tax advisor to understand the best approach based on your situation.

How often should I review my income protection insurance policy?

It’s recommended to review your income protection insurance policy annually or when experiencing significant life changes (e.g., a new job, income increase, or health changes). This helps ensure your coverage remains adequate and relevant.