High price to pay for cover
The beauty of paying premiums for the three types of life insurance available in super – term life (or death benefit), total and permanent and disability (TPD) and income protection – is that you don’t have to find the money from your household budget. In addition to having policies renewed automatically, paying for life insurance within super, to cover those years when you’d need it most, can give you volume discounts, and very often there are no medical tests required.
While insurance through super can provide you with more affordable cover than you’d be able to get from a stand-alone policy, the Productivity Commission in its recent report concluded that the value of this cover to many of the 12 million Australians who have it is questionable. That’s especially true for younger and lower-income people, says Xavier O'Halloran, head of advocacy, Superannuation Consumers’ Centre, at Choice.
Given that young people typically have a super fund opened for them when they first start working, O’Halloran says they are among the people most affected by default insurance. “Many younger workers have discovered to their horror how their small super balances have been eroded by insurance fees they neither knew about, need, nor asked for,” he says.
Since most young people are years away from having a family and paying off a mortgage or school fees, O’Halloran recommends opting out of any default cover they don’t need. As a result, he urges you to consider consolidating multiple accounts – each of which could be charging fees for default insurance cover – into one.
Drag on performance
Based on the Productivity Commission research, a 20-year-old who is on a lower income, has a higher-risk job and pays for insurance via super can be $85,000 worse off in retirement if they maintain a default fund. Then there’s the impact of “unintended multiple accounts”, which based on commission estimates cost members almost $1.9 billion annually in excess premiums.
Over time, the commission says, these multiple accounts can leave the typical worker with 6% less ($51,000) at retirement.
To safeguard young people from unknowingly paying for insurance they don’t need within default super, the Productivity Commission recommends that insurance through super be optin for members under 25. It also recommends trustees stop all insurance cover on accounts where no contributions have been made for 13 months.
Right cover at right time
To ensure you receive the insurance cover that suits you and you’re getting the best value, it’s important you take out the right amount at the right time. For example, research firm Rice Warner suggests that people consider taking out term life cover equal to around 10 times what they would typically earn in a year. For a working couple with a mortgage and young children this may make perfect sense but it doesn’t for someone starting out in their career with few liabilities.
It’s equally important to know how long you should have insurance cover for. The need for it tends to progressively decrease the closer people get to retirement. This usually happens once the mortgage is paid off and school-aged children become more financially independent.
But knowing how long to hold insurance can be also be an art. For example, previous research by life insurer TAL showed that the average age at which a person takes up some form of life insurance is 37.5 years, and it is discontinued 7.5 years later at 45. However, the average age for a claim is 46.5 years, which means after 7.5 years of paying premiums people can find themselves without cover in their hour of need.
When comparing the benefits of paying for life insurance from pre-tax earnings via super with the tax benefits of holding it outside super, it’s important to seek professional advice.