Cross-insurance and insurance reserving are strategies used to provide liquidity to self-managed super funds (SMSFs) with limited recourse borrowing arrangements (LRBAs) to prevent the forced sale of a property in the event of death or disability of a fund member.
The ATO has previously stated its view that cross-insurance arrangements where the proceeds of an insurance policy are paid to someone other than the insured under the policy are not permitted (from 1 July 2014).
As indicated in the recent Minutes of the Superannuation Industry Relationship Network (SIRN) meeting (of 7 April 2016), the ATO appears to have similar concerns with the insurance reserving strategy:
“An insurance reserving strategy would be treated the same way as cross insurance, as the intent isn’t to increase the members benefit, but protect assets held in the fund.”
The ATO will formally confirm its position after it has given this matter further consideration.
Insurance reserving is currently used where the deceased’s beneficiary is unable to receive a death benefit income stream, for example, where the SMSF members are unrelated business partners or siblings, or are not members of the SMSF.
Under the insurance reserving strategy, the insurance is structured so that the proceeds are allocated to an SMSF reserve. This enables the proceeds to be used to provide liquidity to repay the LRBA loan and the death/disability benefit. Since cross-insurance is ruled out and there’s a question mark over insurance reserving, other options to address liquidity should be considered including:
When SMSF members are spouses or family members
- pay death benefit pension to surviving eligible dependant (eg spouse)
- pay death benefit lump sum via in-specie distribution of an interest in the property
- self, cross or trust ownership of insurance outside super – to allow non-concessional contributions or for acquisition of the property (or an interest in it)
When SMSF members are unrelated business partners
- members make non-concessional contributions to allow payment of debt and insured member’s benefit
- cross or insurance trust ownership of insurance outside super – to allow non-concessional contributions or for acquisition of the property (or an interest in it).
- remaining or new members acquire property from fund
Caution needs to be exercised with any insurance strategy where the insurance proceeds are not directly added to the life insured’s existing benefit.
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