SMSF Technical Education & Strategies

TPD Insurance - Tax Deductions for Premiums

For many years, SMSF trustees who have taken out Total and Permanent Disablement (TPD) insurance for its members have been able to claim a full tax deduction for the premiums paid. On the 1st of July 2011, this will change depending on which type of policy you take out.

Here's how it breaks down:

The Tax Act (ITAA 1997) basically states that TPD premiums are deductible to the extent that they relate to a "superannuation disability benefit".

So what is the definition of a "superannuation disability benefit" ? The Act defines it as a superannuation benefit if:

(a) the benefit is paid to a person because he or she suffers from ill-health (whether physical or mental); and

(b) 2 legally qualified medical practitioners have certified that, because of the ill-health, it is unlikely that the person can ever be gainfully employed in a capacity for which he or she is reasonably qualified because of education, experience or training.

The problem is many of the definitions of TPD used in both SMSF trust deeds and various insurance policies do not strictly adhere to the above definition of a superannuation disability benefit, and as such should probably not have been able to claim a full deduction for the premiums. Whilst common industry practice has overlooked this in the past, the Government have basically said enough is enough and as at 1st July 2011, we have to get it right.

So what is the situation from 1st July 2011 ?

In 2010, the ATO issued a draft ruling (TR 2010/D9) which outlined their proposed approach. Essentially, trustees will only be able to claim a deduction (either 100% or less) of that part of a TPD premium that relates to the provision of benefits that strictly meet the above definition of a "superannuation disability benefit". This definition is similar to the definition of permanent incapacity as a condition of release from a super fund, so you can see it starts to make logical sense.

So essentially, any TPD policy that provides benefits in a broader range of circumstances than that stated in the above definition, the premiums will only be partly deductible, and an actuarial certificate will be required to determine the portion of the premium for which a tax deduction can be claimed.

What does this all mean in practice ?

In practice, it all comes down to the type of TPD policy you take out, and what other bits you include.

There are generally two main types of TPD definitions used:

1. Any occupation, and;

2. Own occupation.

The "any occupation" definition is generally one where due to ill health you are unlikely to be employed in ANY occupation for which you are reasonably qualified by education, training, or experience. This is generally regarded as meeting the definition of a "superannuation disability benefit" - that is, you should be able to claim 100% of the premium as a tax deduction for these TPD policies.

The "own occupation" definition however is a different story. As the name suggests, its where due to ill health you are unlikely to ever be employed in your OWN occupation again. This of course is a more generous definition than the "any" occupation definition. As such, these premiums will not be fully deductible, and you'll need an actuarial certificate to work out how much is deductible (i.e. how much of the premium relates to the SMSFs liability to pay a "superannuation disability benefit"). This certificate of course will come at a cost.

The other point to make here about "own occupation" TPD inside a SMSF is that because of the more narrow definition, you can be in a situation where an event has happened (say the loss of one limb) where you qualify for a payout of the insurance (the SMSF receives the money) but because the disability is not sufficient to qualify under the more onerous definition of "permanent incapacity" under the 'condition of release' rules, the money may be stuck in your SMSF and you can't get it out until another condition of release is met. Hence there is an argument for having "own occupation" TPD insurance outside of super.

What about when other bits are added to either policy ?

Sometimes there are other definitions that are added to a TPD policy, and these can have an effect on the above scenerios.

Loss of sight and/or limbs

Where an "any occupation" TPD policy is enhanced with a definition that says that you are deemed to be totally and permanently disabled if you lose both limbs, or the sight of both eyes, or lose one limb and one eye etc, the premium will not be 100% deductible, and you'll need an actuarial certificate. This is due to the fact that it is not certain that such events will lead to a member meeting the "superannuation disability benefits" definition.

Activities of daily living

On the other hand, a TPD policy can be enhanced with a definition around the loss of independence in daily living. This might typically say that you have lost independence if you cannot perform two or more activities (from a list) without the physical help of someone else. This list would include things like bathing/showering, using the toilet, eating and drinking, getting dressed, moving around and getting out of bed etc. In this situation, it is accepted that it is highly unlikely that the person would be able to work again in any occupation for which they are qualified, and as such it would meet the "superannuation disability benefit" definition, and the premiums would be 100% deductible

Summary table

Other points

- review what your trust deed says about TPD (and any definitions). The ATO draft tax ruling makes a number of references to the terms of the fund trust deed being able to provide a 'disability superannuation benefit' to a member. Make sure you don't have a mismatch there.

- some insurance product providers have already moved to accommodate the changes mentioned above for an "own occupation" policy, whereby cover is split into two linked policies. That part of the cover which relates to an "own occupation" definition is held inside the SMSF, while the balance is held outside super. This allows the policy inside the SMSF to be fully deductible, while enabling you to maintain a full overall "own occupation" cover.