Why Consider Insurance for an SMSF with an LRBA
Self-Managed Superannuation Funds SMSFs with Limited Recourse Borrowing Arrangements LRBAs offer a great opportunity to acquire valuable assets like property. However, they also come with risks, especially if a member passes away or becomes incapacitated. Insurance can be a vital tool to mitigate these risks, ensuring the SMSF meets its financial obligations and protects its assets.
Address Liquidity Shortfalls
In the event a member dies or becomes incapacitated, insurance proceeds can cover loan repayments and benefit payments. This prevents the need to sell valuable assets, ensuring the SMSF retains its investments.
Protect Key Investments
If the SMSF owns a commercial property tied to a family business, selling it to an unrelated third party could disrupt operations. Insurance provides the liquidity needed to keep ownership within the family and maintain business continuity.
Avoid Forced Asset Sales
Insurance proceeds can ensure the SMSF has enough funds to manage tax liabilities, debts, and benefit payments. This avoids the need to liquidate key assets, preserving the long-term value of the fund.
Types of Insurance to Consider
- Life Insurance: Covers the repayment of LRBA loans and provides liquidity to fund death benefits.
- Total and Permanent Disability TPD Insurance: Addresses financial obligations if a member becomes permanently incapacitated.
- Income Protection Insurance: Ensures the SMSF can maintain contributions and service LRBA debt during temporary incapacity.
Strategic Considerations for SMSF-Owned Insurance
Tax Implications
Insurance proceeds added to a deceased members account form part of their death benefit, which may attract tax if paid to nondependents.
Beneficiary Preferences
Consider whether beneficiaries prefer a lump sum or a pension to maintain property ownership.
Fund Liquidity
Regularly review the SMSFs liquidity to ensure it can meet tax and debt obligations without selling assets.
Case Study: Single Member SMSF
Scenario:
Jacob is the sole member of his SMSF, which owns a residential property valued at $800,000, financed by a $500,000 LRBA. Jacob’s balance is $410,000, and the SMSF holds $110,000 in cash and shares.
To mitigate risks, Jacob’s financial adviser recommends $500,000 in life and TPD cover. After Jacob’s sudden passing, the SMSF receives $500,000 in insurance proceeds, which are used to repay the loan. The property remains in the SMSF, now unencumbered, and Jacob’s spouse receives the death benefit.
Key Outcomes:
The SMSF retains ownership of the property.
The death benefit is paid without selling assets, preserving long-term value.
Alternatives to SMSF-Owned Insurance
Insurance Outside Super:
Members hold personal insurance policies and contribute proceeds to the SMSF upon a trigger event.
Advantages: Avoids adding insurance proceeds to the member’s account balance, reducing taxable death benefits.
Challenges: Premiums are not tax-deductible, increasing out-of-pocket costs.
Joint SMSF and Personal Insurance Strategies:
Combining SMSF-owned and personal insurance ensures both liquidity and tax efficiency.
