Income protection: inside or outside super?

Income protection insurance can be a financial lifesaver if you get sick or injured and can’t work for a while. It provides a monthly income to help cover your living expenses during tough times. You can get this insurance either through your superannuation fund or as a separate policy (retail insurance). Each option has its own pros and cons. Let’s break down the key differences so you can decide what’s best for you. 

Default income protection through super 

Getting covered by your super fund 

Most super funds offer default income protection insurance to their members. This means premiums are deducted automatically from your super, so you don’t have to worry about monthly payments. However, only getting covered by your super fund can impact your retirement savings, and if you change funds, your cover might end. 

These default policies are often one-size-fits-all. Depending on your fund, you might not be able to customise your cover to suit your individual needs, and you could have limited options for waiting periods or benefit durations.

Pros  

• Easy payment: Premiums are paid from your super balance, which can help with managing your cash flow. 

• Tax withheld: The trustee of the superannuation fund will generally withhold PAYG tax on benefit payments before the monthly benefit is paid to the client.

Cons 

• Low cover: Default cover is often low and might not meet your needs. Increasing cover levels can make it more expensive than retail options. 

• Medical underwriting: Default group insurance is often not medically underwritten. Your medical history might be assessed at the claim stage, which can complicate claims for pre-existing conditions. 

• Reducing cover: Group policies often reduce cover as you age. Your insurance cover might decrease without notice. 

• Conditions of release: You must meet the temporary incapacity condition of release under superannuation law before the trustee can pay the benefit, as well as being gainfully employed at the time of claim. 

• Payment delays: Benefits are generally paid to the trustee first, causing potential delays. 

• Impact on retirement savings: Premiums can erode your super balance if you don’t make extra contributions. 

• Less flexibility: Group insurance is tied to your super fund. If you change super funds, your contributions end, or your super account becomes inactive, your group insurance may be cancelled, and you could end up with no insurance.

As seen in the image, super funds can change their insurance terms which might reduce your coverage unexpectedly. These changes can impact the value and reliability of your insurance over time, potentially leaving you with less cover than anticipated. 

Income protection outside of super 

Customised coverage with retail insurance 

When you choose income protection insurance directly through an insurer or financial adviser, you gain flexibility. You can tailor your cover to fit your needs and budget, add benefits that matter to you, and often get shorter waiting periods and longer benefit payment periods compared to default super fund policies. Plus, many insurers offer discounts for paying premiums annually. 

Another advantage of income protection outside of super is that you can usually claim the premiums as a tax deduction. If you make payments before June 30, they will generally be tax-deductible in the same financial year.

Pros 

• Cost-effective: More often than not, group insurance becomes more expensive than comparable retail cover when sums insured are increased to a level you might actually need. 

• Payment options: With retail insurance, you can choose to pay through super, from your cashflow, or a combination of both. This flexibility allows you to pick what works best for your financial situation.

• Renewability: Group insurance contract terms can change anytime due to negotiations between the employer/superannuation provider and the insurer, often leading to reduced policy quality. In contrast, retail insurance policies are generally ‘guaranteed renewable,’ meaning your policy can only provide additional or upgraded benefits while in force. You won't see a downgrade in benefits once your retail policy is in place. 

Source: NEOS Protection 

• Medically underwritten: Retail insurers assess medical information upfront, so you are fully aware of what you can and can’t claim in the future. 

• Tax deductible: Premiums are generally tax-deductible if you are both the life insured and the policy owner. 

• Employment flexibility: It may provide protection even if you’re not employed at the time of incapacity. 

• Customisable policies: Can be tailored to personal needs and available under different ownership structures, like for covering business expenses. 

• Lump sum option: May offer the ability to exchange ongoing payments for a lump sum benefit. 

Cons: 

• Partial tax deductibility: If the policy provides benefits of an income and capital nature, only the income benefit portion of the premium is deductible. 

• Tax liability: PAYG tax is generally not withheld from benefit payments, so you may need to budget for tax liabilities within that income year. 

Tax laws in Australia can be tricky, so it's a good idea to chat with a qualified financial adviser or registered tax agent before making any decisions. 

When deciding between income protection insurance inside or outside of super, consider the benefits and drawbacks of each option. Consulting with a financial adviser can help you navigate these options and find the best policy for your specific situation.