SMSF Income Protection Insurance: What to know
If you run a self-managed super fund (SMSF) and you're temporarily unable to work, income protection insurance could provide a crucial buffer for your retirement savings.
- SMSFs don't offer default income protection insurance; it needs to be sourced and set up either inside or outside the SMSF.
- Income protection can replace 70-85% of your income if illness or injury stops you from working.
- Income protection insurance is tax-deductible whether held inside or outside an SMSF.
- Trustees can get income protection insurance through an insurance broker, financial adviser, or insurance company.
Income protection insurance can provide a safeguard in the event you become sick or injured and unable to work, leaving you unable to make your usual SMSF contributions.
Because SMSFs don't offer default insurance the way industry and retail funds do, understanding how income protection works, inside or outside the fund, can help you decide whether it's the right fit.
Besides, it is optional - so it's important to know your options.
What is SMSF income protection insurance?
Most industry and retail super funds offer default income protection insurance for members. SMSFs do not. If you want this type of cover, you'll need to source and set up the policy yourself, and decide whether to hold it inside your SMSF or personally, outside super.
Income protection insurance typically pays between 70% and 85% of your pre-tax income if you're unable to work due to illness or injury.
According to Moneysmart, the purpose of income protection is to replace the earnings you'd normally receive from employment.
Essentially, it means you'll receive a portion of your paycheque from your usual nine-to-five, even if you're spending that time out of action. This saves you from needing to stress about finding money to cover bills, loan repayments, or even just putting food on the table.
This type of cover is especially handy if:
- You're self-employed or run a small business
- Your family depends on your income
- You have debts you'd struggle to service without work
- You prefer certainty around cash flow
Do SMSF members need insurance?
SMSFs are not required to provide insurance to members. However, under superannuation law, trustees must consider each member's insurance needs as part of the SMSF's investment strategy.
This is a compliance requirement overseen by the Australian Taxation Office (ATO).
When considering what's "appropriate", trustees should examine:
- How much debt each member has
- Whether they have dependants
- How dependants would be supported if the member couldn't work
- What non-SMSF insurance they already hold
Other types of insurance that can be held via an SMSF include:
- Life insurance (death cover) - pays a lump sum or income stream if the member dies or becomes terminally ill
- Total and permanent disability (TPD) insurance - pays a benefit if the member becomes permanently unable to work
Industry and retail funds usually provide these by default. SMSFs do not, so trustees must set them up manually.
Pros and cons of holding income protection insurance in an SMSF
If you decide income protection is worth considering, the next question is whether to hold it inside or outside the SMSF.
Here's how holding it inside the fund stacks up.
Pros
- Premiums are tax-deductible to the SMSF (at 15%)
- No personal out-of-pocket costs, as premiums are paid from members' contributions
- May improve personal cash flow, since you're not paying premiums yourself
- Greater ability to customise the policy compared with standard retail or industry fund options
- The application process can be straightforward when setting it up through an adviser or insurer
Cons
- Premiums may be more expensive due to the smaller fund structure
- Medical underwriting is usually required, unlike default cover in retail funds
- Claims can take longer, as trustees must satisfy superannuation law and trust deed obligations
- Benefit payments to non-dependants are often taxable
- Benefits can only be paid for periods of incapacity, due to super's "conditions of release"
- Insurance costs reduce SMSF balances, potentially impacting long-term retirement savings
Is there a tax advantage to holding income protection insurance inside your SMSF?
Income protection premiums are generally tax-deductible whether held inside or outside super, but the deduction rate differs:
- Inside an SMSF - Deductible at the fund's tax rate of 15%
- Outside super - Deductible at your marginal tax rate, which may be as high as 45%
This means higher-income earners can often claim a larger deduction by holding income protection personally, not inside the SMSF.
Benefit payments are treated by the ATO as replacement income, meaning they are taxable whether the policy is inside or outside super.
Income protection insurance outside your SMSF
Holding income protection personally - separate from your SMSF - may offer:
- Broader coverage (e.g. cancer benefits, trauma-style payments, specified injuries)
- More flexibility around waiting periods and benefit periods
- Simpler claims processes
- No depletion of SMSF retirement savings
However, premiums may be higher, and the cost comes directly from your own cash flow rather than SMSF contributions. Though you might be better suited to coverage inside your SMSF if you're just looking for a basic backbone in the case of temporary work absence
In short, the "better" option depends entirely on your situation, income level, and desired level of cover.
How to get income protection insurance
You can purchase an income protection insurance premium through an insurance broker, a financial adviser, or an insurance company.
When you apply, expect to provide information such as:
- Age
- Occupation
- Income (salary, wage, commissions, bonuses)
- Medical history
- Lifestyle factors (e.g. smoking)
- High-risk hobbies (e.g. scuba diving, skiing, motorsport)
This helps the insurer determine whether they will cover you and at what price.
What SMSF trustees should know
As an SMSF member, you must act in the best financial interests of all members and ensure the fund's investment strategy is robust. While SMSFs don't have to hold insurance, trustees need to show that insurance needs have been considered.
Whether income protection, life, or TPD insurance is held inside or outside the fund will depend on:
- Cost vs benefit to the fund
- The tax implications for members
- How flexible or restrictive the policy is
- Whether insurance premiums will erode retirement savings
- Each member's personal financial position
If the cons outweigh the pros for the majority, insurance might be better off being held personally, rather than inside the fund. The choice depends on what's most financially beneficial for all the fund members.
Savings.com.au's two cents
Income protection insurance can provide peace of mind if illness or injury stops you from working. But because SMSFs don't offer default cover, members must think carefully about how to structure it and whether the fund or the member should foot the bill.
There's no one-size-fits-all answer. The best approach is to consider the tax implications, policy features, and long-term impact on your retirement savings before making the call.
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