Article supplied by The SMSF Club
When considering starting out in your pursuit to live a life of abundance in retirement, you need to be properly prepared for any hiccups that may occur along the way.
When it comes to investments, both direct property and shares often operate in cycles of boom times and busts. When you incorporate gearing into your investment strategy these highs and lows are magnified. You should therefore always have a backup plan to protect you and your family, from not just adverse market movements, but also a plan to cover any personal disaster.
There are many types of insurances, and if you are a property investor, you should consider having almost all of them. Most properties are usually very big and expensive, and generally the attached loans are the same – you need to be protected from any unforeseen circumstances.
Home and Contents Insurance
The first and most obvious protection policy is house and contents insurance. This type of insurance ensures the building can be rebuilt if certain things occur such as fire. If you are not protected and your investment property is not covered, the lost rental income, and the decline in the asset value could set your retirement plans back many years. If you have borrowed money inside of your SMSF to fund the purchase, the bank may force you to sell the damaged property. The last thing you want is the bank forcing you to sell a damaged property, as the price you receive may only cover the borrowed amount.
Land Lord Insurance
In connection with house and contents insurance, another must have protection policy is land lord insurance. This type of insurance policy covers lost rent if the house becomes uninhabitable. This could be caused by many reasons such as fire or if you have the tenant from hell. Remember in Australia most rules protect the tenant – if they stop paying rent it can often take over 6 months to evict them. In such times, landlord insurance can cover some of the loss.
Both house and contents insurance, and landlord insurance are designed to protect the property itself and the SMSF in this case. These costs are generally tax deductible to the SMSF.
Personal Risk Insurance
Personal risk insurances are aimed at insuring yourself and your family. When it comes to property investing, it is important to make sure that the investment strategy you have developed inside of your SMSF doesn’t have to be cancelled early, should one of life’s disasters happen to you.
When it comes to property investing, most people borrow to fund the purchase, especially inside of their SMSF. The 9% employer super contribution is one of the main sources of income used to pay the interest expense, and to reduce the debt on the loans. If these contributions suddenly stop, you need to have a safety net to protect your properties, to protect your retirement, and to protect your family’s future.
You may be forced to cut back hours, or stop work altogether as a result of three main reasons: trauma, total and permanent disablement, or death. To protect you and your family in these times, you should consider trauma insurance, total and permanent disablement insurance, life insurance, and income protection insurance. The first three pay a lump sum in the event of death, an injury that makes you no longer capable of working, or a traumatic illness such as a heart attack or cancer. Income protection insurance insures a portion of your income if you suffer from an illness or an accident that prevents you from working for an extended time.
The premium or cost of these insurance policies can be paid directly out of your SMSF.
Life insurance pays a lump sum to your beneficiaries in the event of your death – most Australians can take out life insurance in their SMSF. The premium will be paid out of your super, meaning it doesn’t cost you any money upfront, or any on-going costs out of your own back pocket.
Life insurance premiums inside an SMSF are also usually tax deductible for the fund, although if you did take out the policy in your own name, the premium does not qualify for a tax deduction. If you die and the life insurance is held inside of your SMSF, the lump sum payment will be paid into your SMSF. You need to ensure you have drafted within the SMSF trust deed that in the event of death, any proceeds in the fund to be paid out to your estate.
When deciding on the amount of life cover one main thing you need to take into consideration is your debt. If you have a lump sum payment, and this amount covers all of your debt, inside of your SMSF and outside, your family can continue with the investment strategy you have developed and live off the rent. If you do not have any form of life insurance, then your family may be forced to sell all assets to cover the debt you have left them with.
Total and permanent disability insurance (TPD)
TPD insurance is often referred to as life insurance for the living. Normally no one sees the payout of a life insurance policy until they die. TPD insurance works in the same way as life insurance, and sometimes in conjunction with life insurance, however the lump sum payout is paid to you while you are still alive.
You can use the insurance payout to pay off debts, so that your family does not have to deal with the financial liability of paying for the interest. You can use the payout to pay for ongoing bills, which is especially critical if you are the primary source of income for your family. You can use the payout to pay for on-going medical expenses, so your partner does not have to take on additional work just to survive.
TPD insurance covers major accidents and illness through a lump sum payment similar to life insurance. TPD could be caused through an accident which causes a loss of limb, eyesight, or an illness that permanently stops you from working. The lump sum payment is designed to help you make the required lifestyle changes and to pay off debts, so that you can supplement your lost income from income paid on your investments. If you are a property investor you may want all of the debt paid off to ensure you are not forced to liquidate your assets.
What is covered under each insurers list of TPD events varies widely. You should read the disclosure document to determine what is and what isn’t covered before making a decision as to who you should have TPD insurance with. Like Life Insurance, TPD insurance is tax deductible when the policy is owned by the SMSF. However the policy is not a tax deduction if taken out in your own name. A TPD payout inside an SMSF also relies on the trustees of the SMSF agreeing to pay out to the individual. This condition is usually a formality in most cases, but never the less a small risk of having the policy in an SMSF. Often the trustees of an SMSF are family members, making it easier to come to these decisions.
In today’s society, and with advanced medical treatment, you can live for a long time with many forms of series illness. The most common are heart attack, strokes, or cancer.
Trauma insurance is aimed to provide a lump sum payment to cover all on-going medical treatment required to keep you alive, likewise any one off expenses that are needed to modify your house and lifestyle to ensure a comfortable existence. The main difference between Trauma and TPD insurance is that Trauma cover is designed to cover bills and expenses while you recover, while TPD insurance covers conditions which are viewed as permanent. Again the premium or costs associated with trauma insurance can be paid by the SMSF; the cost is not tax deductible.
Income Protection Insurance
For most people under the age of 50, their biggest financial asset is generally their future income capacity. That is, their ability to work. If you are 35 years old and earning $85,000 a year, then you are likely to earn a total of over $2.5million by the time to turn 65.
Income from your salary and how that funds your property investments in and outside of your SMSF is fundamental to any wealth creation strategy.
Most Australians will insure their $40,000 car every year without hesitation, and pay the $1,000 premium. However the same person will never even consider spending the same amount to insure their income. Income protection insurance usually covers up to 75% of your salary for a defined period of generally between 2-5 years, or until a certain age such as 65.
Income protection insurance is the most flexible type of personal risk insurance, but arguably the most important for a property investor.
If an investor was no longer able to work, the loss of income is bad enough, but if they had two negatively geared investment properties in their SMSF they will eventually be forced to sell those properties as the SMSF can no longer service the loans. The loss of income and the loss of the super contributions would be very serious. Again income protection can be paid for out of your SMSF and is tax deductible.
Insurance is complicated, and while most is tax deductible inside of your SMSF, it may be more beneficial to hold the insurance in your personal name.
It is critical you seek independent advice regarding your own individual insurance requirements.
Home and contents insurance and landlord insurance are simple and straight-forward, as most people can identify the risks these protection policies overcome. The benefits of personal risk insurance when it comes to property investing are less obvious. Less than 5% of the Australian population have adequate personal risk insurance. For a small premium, which can be paid out of your SMSF, and is tax deductible (excluding trauma insurance), serious financial problems can be avoided.
Be a sophisticated property investor, be a responsible parent and or partner. Take out insurance to protect yourself and your family.
If you would like to learn more about Self Managed Super Funds, register now for the next SMSF Education Evening, hosted by Justin Beeton, Founder and Managing Director of The SMSF Club.
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Disclaimer: while due care is taken, the viewpoints expressed by contributors and/or sponsors do not necessarily reflect the opinions of Your Investment Property.
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