Partners Superannuation Services director of SMSF consulting and auditing Martin Murden said the problems associated with purchasing buy/sell insurance this way outstrips the benefits, however.

Mr Murden said if there is a requirement for the insurance policy to be held by each partner’s SMSF in the agreement between the business partners and the proceeds arising from the insurance claim are to be used as payment for the deceased’s interest in the business, then the SMSF could fail the sole purpose test under SIS.

This would lead to an increase in the fund’s tax rate from 15 per cent to 49 per cent, he said.

Mr Murden also said if the agreement does not specifically state the insurance proceeds in the SMSF be used as funding to allow the agreement to be completed, there could be difficulties forcing the beneficiary to hand over the interest in the business for what would appear to be nothing.

“If the fund has already paid the insurance proceeds to the deceased's spouse/partner as part of the death benefit, why would they transfer an interest in the business for what appears to be no payment?” he said.

Insurance premiums, he said, will also be deducted from contributions made to the SMSF and because there are restrictions imposed on the amounts that can be contributed, this will reduce the amount available for investment, which in turn will lead to lower retirement benefits for members.

If the beneficiary is not a tax dependent, Mr Murden also said additional tax is payable on the insurance portion of the death benefit.

“When a lump sum benefit is paid to a non-tax dependent, tax is payable at the rate of 17 per cent including the Medicare levy,” he said.

“Any insurance component of such a benefit is taxed at 32 per cent.”

The focus, he said, should be on having the appropriate insurance cover and a buy/sell agreement in place, rather than small tax deductions.