Structuring TPD for certainty and tax deductibility

When you recommend total and permanent disablement (TPD) cover to clients working in professional or highly specialised occupations, you will often have to give some thought to the ‘own occupation’ definition.

As the inability for your client to work in their own occupation can lead to a significant loss of earning capacity, the ‘own occupation’ definition provides greater certainty that your client will be paid a benefit.

Structuring ‘own occupation’ TPD cover in super raises the spectre that the benefit gets trapped as the client is unable to meet the ‘permanent incapacity’ test. That is, the trustee must be satisfied that the life insured is unlikely, because of ill health, to ever engage in gainful employment for which they are reasonably qualified by education, training or experience (ETE).

But if TPD cover is structured outside of super, the premiums are not tax deductible. So the challenge is to find the right structure that gives your client greater certainty that they would qualify for a benefit, but also takes advantage of the tax deductibility of premiums.

AIA Australia’s Maximiser benefit is structured in such a way that it maximises the certainty of payment while maximising opportunities for tax deductions.

Under the Maximiser benefit, cover is structured inside and outside of super. Cover is under the one plan but with two policies issued; one in Super and one outside of Super.

Tom Gordon

National Technical Sales Manager - Product

Copyright © 2013 AIA Australia Limited (ABN 79 004 837 861 AFSL 230043). All rights reserved. This information is intended for financial advisers only and is not for wider distribution. This information is current at the date of distribution and is subject to change. This is general information in summary only, without taking into account the objectives, financial situation, needs or personal circumstances of any individual, and may not be exhaustive. It is not intended as financial, legal, medical or other advice.

John is involved in a traffic accident and loses the use of one arm.

John is first assessed against the 'any occupation’ definition under the super policy. To be eligible for a benefit he must satisfy the policy definition for 'any occupation’ and the ‘permanent incapacity’ condition of release under superannuation law.

Because John is able to perform other occupations for which he has education, training or experience, such as working in general practice, he does not meet the 'any occupation’ policy definition.

Since John has the Maximiser benefit, the claim can then be assessed under the ‘own occupation’ definition outside of super. John meets the ‘own occupation’ policy definition so is paid a benefit of $1,000,000. As the benefit is paid outside of super, it attracts no tax.

Both polices are then cancelled.

[1] Premium calculations current as at 16 May 2012

[2] Including Medicare levy

[3] Assumes John has 30 years of completed service and became disabled on his 53rd birthday. The tax free component is calculated using the formula (Amount of benefit x days to retirement / (service days + days to retirement).

Making a claim

How would John’s claim be assessed if he has an accident?

Consider the tax implications

How would this scenario have concluded if John had met the ‘any occupation’ policy definition and was eligible to receive the benefit through super?

How is Maximiser structured?

Let’s look at an example of how it is structured for John, a 44-year-old orthopaedic surgeon (AA category).

The total monthly premium for John is $92.21¹ per month. The monthly premium for the ‘any occupation’ policy is $63.45 and this is deductible by the super fund trustee. The ‘own occupation' loading is $28.76 per month and since the policy is structured outside of super, the own occupation premium is not tax deductible.

Because the ‘any occupation’ policy is held in super, John may be liable to pay tax on his benefit depending on the age it is paid to him.

John suffers his permanent disablement at 53, meaning that the taxable component of his benefit is taxed at 21.5%2.

Using the proportioning rule³ which takes into account his service period start date and date of permanent disablement, almost $286,000 of his benefit is deemed tax-free.

The remaining $714,000 is then taxed at 21.5% leaving him with a net benefit of just under $847,000.

To overcome this shortfall, John and his adviser can increase the sum insured in the ’any occupation’ policy to compensate for any tax.  As John gets older, the rate of tax he pays will reduce and he would pay no tax on his TPD benefit if it is paid to him when he is aged over 60 and this provides an opportunity for his adviser to review the sum insured.

To find out more about AIA’s insurance solutions for super , contact a member of our Client Development team today.