SMSFs warned on insurance snare with LRBAs
SMSF practitioners arranging insurance for clients should be careful about where the insurance is being allocated, with SMSF clients likely to fall into traps with SMSF loans, an insurance expert has warned.
ClearView Wealth head of product Jeffrey Scott explained that one of the most common traps he sees with insurance and limited recourse borrowing arrangements in SMSFs is that when the insurance policy is set up inside the fund, it gets allocated to a particular member’s account.
What the trustees of the fund normally want to do, he explained, is set it up so that when one of the members passes away, the insurance money will come into the super fund so that they can pay of the debt associated with the LRBA.
“Where the policy has been allocated to a particular member’s account, [however] the insurance money increases their account balance but it doesn’t actually pay off the loan,” said Mr Scott.
“So what ends up happening is that the deceased member, their account increases, the money comes out of the fund, but the super fund itself is still left with this significant limited recourse borrowing arrangement loan, and that becomes a problem for the surviving members of the fund.”
One solution where it’s a husband and wife fund, and they have a loan for an investment property, for example, he said, is to pay the death benefit as a pension or an income stream instead of a lump sum.
“That way they can keep the property inside the fund, pay of the loan, and use the rental income from the property to pay the death benefit pension,” he said.