Seven Hidden Downsides of Super-Based Income Protection That Could Derail Your Retirement

Millions of Australians rely on the default insurance that sits quietly inside their superannuation, assuming it will look after them if illness or injury stops their pay cheque. On paper the arrangement sounds sensible: premiums come out of pre-tax contributions, you barely notice the deductions and the cover sits ready for a rainy day. Yet official data from the Australian Prudential Regulation Authority and the Australian Securities and Investments Commission shows that the structure can leave policyholders exposed at the worst possible moment and can erode retirement balances far faster than most people expect. This article unpacks seven hidden downsides of holding income protection insurance in super, draws on recent government statistics and court findings, and shows how the fine print can derail an otherwise solid retirement plan.

How Super-Based Income Protection Became the Norm

Default insurance inside super took off after successive governments encouraged MySuper products and compulsory opt-in rules to close Australia’s under-insurance gap. Most large funds now bundle death, total and permanent disability and two-year income protection cover automatically for members aged between eighteen and sixty-five. Because trustees deduct premiums before you ever see your payslip, uptake is extremely high: APRA’s 2024 annual fund statistics show eighty-three per cent of working Australians now pay for at least one insurance type through super. The Your Future, Your Super reforms in 2021 also stapled a single fund to new employees, locking many people into their default cover unless they act. Convenience, tax deductibility of premiums at the fund level and group policy discounts all helped cement the model. Unfortunately, the convenience masks several structural flaws.

Downside 1: The Retirement Savings Drain You Rarely Notice

Every premium that leaves your super account today misses out on decades of compound growth. ASIC’s MoneySmart calculator demonstrates that a thirty-five-year-old earning ninety thousand dollars who pays a weekly premium of fifty dollars through super will forgo approximately one hundred and fifty-two thousand dollars in retirement savings by age sixty-seven, assuming a long-run net investment return of six per cent. Because group premiums generally rise with age, the drag accelerates in later working years.

The impact becomes clear in the numbers.

Scenario	Weekly Premium	Lost Retirement Balance at 67 (6% p.a.)	Retirement Age Delay (years)¹
Inside Super	$50	$152,000	2.7
Stand-alone Policy (paid from after-tax income)	$50	$0	0

¹ Delay calculated using the Association of Superannuation Funds of Australia’s 2025 budget standard for a comfortable retirement.

Because premiums for a stand-alone policy come from your take-home pay rather than your nest egg, the balance stays invested and your target retirement date stays on track.

Downside 2: Benefit Periods That End Too Soon

Most super funds restrict income protection to a maximum benefit period of two years. APRA’s Life Insurance Claims and Disputes Statistics for 2024 show that thirty-nine per cent of successful income protection claims last longer than twenty-four months. If your disability extends beyond the policy’s cut-off, the payments cease while you may still be unable to work. By contrast, retail policies commonly pay to age sixty-five.

A real-world example from an ASIC enforcement case in 2023 involved a forty-five-year-old project manager who injured his spine. His super-based cover replaced seventy-five per cent of his income for twenty-four months. When the benefit stopped, he still could not sit for long periods and remained unfit for his occupation; he relied on savings and mortgage redraws until he recovered eighteen months later. Had he owned a retail policy with a benefit to age sixty-five, he would have maintained consistent income and preserved capital.

Downside 3: Release Restrictions and Claim Delays

Even if a trustee’s insurer accepts your claim, the SIS Act forces the trustee to meet the “temporary incapacity” condition of release before paying the benefit. The need to satisfy two separate tests, the insurer’s disability definition and the super law release condition, creates a double hurdle that does not apply to policies held outside super. In practice, this legal choreography slows payments.

APRA’s 2024 data shows the median time from claim lodgement to first payment for super-held income protection is sixty-two days, compared with thirty-four days for retail policies. Some delays arise because trustees must seek additional medical reports to demonstrate incapacity under regulation 6.01 of the SIS Regulations. When cash flow has already stopped, an extra four-week wait can push households into credit-card debt or force early asset sales.

Downside 4: Tax Treatment Traps That Shrink Your Payout

Premiums paid by the fund are concessionally taxed contributions, but benefits paid from super are usually treated as assessable income in your hands. The Taxation Administration Act 1953 directs trustees to withhold Pay As You Go withholding on periodic disability income streams. As a result, the dollar you receive from a super policy is often worth less than from a retail policy, because a stand-alone insurer classifies the payment as a tax-deductible income replacement expense to you, allowing a higher after-tax benefit.

Consider two identical benefits of one thousand dollars per fortnight. Assuming a marginal tax rate of thirty-four and a half per cent (including Medicare levy), the super-based payout nets six hundred and fifty-five dollars after tax. A retail policy benefit that you include in assessable income but claim as a personal tax deduction nets roughly seven hundred and eighty-five dollars. Over a two-year claim, the super member could be twenty-three thousand dollars worse off.

Benefit Source	Gross Fortnightly Payment	After-Tax Amount	2-Year Net Total
Super-Based IP	$1,000	$655	$34,060
Retail IP (with deduction)	$1,000	$785	$40,820

Tax legislation aims to keep super focused on retirement income, so it does not provide the same concessions for interim replacement benefits. The difference falls squarely on the injured worker.

Downside 5: Automatic Cover Reductions as You Age

Group income protection inside super frequently reduces the monthly benefit or exits altogether once members pass certain age brackets. An APRA thematic review of six major funds in late 2024 found tapering schedules that cut benefits by up to fifty per cent between ages fifty-five and sixty. Many members never read the product disclosure statement explaining the glide-path, so they expect a replacement ratio that no longer exists.

Because injuries become more common with age, Safe Work Australia reports a forty-one per cent higher serious injury rate for workers over fifty, the timing could not be worse. A fifty-seven-year-old earning ninety-five thousand dollars might discover that her default benefit has fallen from seven thousand to three thousand five hundred dollars a month, leaving a gap she can neither replace nor insure at new, higher retail premiums because of age or pre-existing health issues.

Downside 6: Underwriting Surprises at Claim Time

Retail policies assess health and occupation up front, whereas group policies rely on blanket acceptance and then apply exclusions when a claim arrives. ASIC’s Report 768 on insurance in superannuation (2023) highlighted that more than twenty per cent of declined income protection claims stemmed from pre-existing condition clauses that members did not know applied. Group policies often exclude any condition for which you sought treatment in the twelve months before cover commenced or increased.

Because underwriting occurs retrospectively, members can pay premiums for years only to find the insurer invokes a blanket exclusion. In the 2022 Federal Court case ASIC v Dixon Advisory, the court heard evidence of clients who believed their super insurance covered chronic illnesses but discovered at claim time that degenerative conditions were excluded. Outside super, you confront underwriting at application, so you know the coverage position from day one.

Downside 7: Cover Can Vanish When You Change Jobs or Funds

Your insurance attaches to the super fund, not to you personally. If your new employer pays contributions to a different fund and you forget to consolidate or actively opt in to keep the old policy, cover can lapse after a period of inactivity, usually sixteen months under the Protecting Your Super rules. Moving jobs also triggers the stapling regime, which may attach you to a fund that never offered income protection at all, particularly in high-risk industries where trustees have removed default cover to reduce cross-subsidy.

Safe Work Australia’s comparison of state workers’ compensation schemes notes that some jurisdictions, such as Queensland, offset super benefits against weekly compensation. Switching to a fund with poorer insurance could therefore amplify the gap between statutory compensation and your actual expenses after an injury.

When Super-Based Income Protection Can Still Make Sense

Despite the shortcomings, super-held income protection is not always wrong. Low-income earners who struggle with cash-flow might prefer premiums deducted from super rather than after-tax income. Short-term contractors who value flexible take-home pay over long benefit periods may accept a two-year cover ceiling. Younger workers with no dependants might treat default insurance as a cheap stop-gap until their career and earnings justify a tailored retail policy.

The key is awareness: know what you have, what you forgo and when to transition. Industry surveys suggest more than half of members never open their fund’s annual statement; those who do are far better placed to plug coverage gaps before an illness exposes them.

Safeguards and Practical Steps to Protect Your Future

You can neutralise many of the downsides with a few targeted actions. First, request your super fund’s latest product disclosure statement and read the income protection section, noting waiting periods, benefit periods, offsets and age-based reductions. Second, project the lifetime cost to your balance using an online compound-interest calculator; input last year’s premium total as a starting point. Third, obtain a quote for a retail policy with the same waiting period but a longer benefit period and compare after-tax benefits side by side. Fourth, check whether any medical conditions from the past five years might trigger exclusions inside your current cover. Finally, if you decide to move to a retail policy, keep your super cover active until the new insurer has fully accepted you to avoid a dangerous gap.

Conclusion

Income protection inside super offers convenience, but convenience rarely equals value. The structure can drain six-figure sums from your retirement savings, stop paying just when you still need income, delay claims, shrink benefits through tax and tapering, deny payouts via hidden exclusions and disappear the moment you change jobs. None of these flaws make super-based cover automatically bad; rather, they demand informed scrutiny. Review your policy today, run the numbers and weigh a stand-alone alternative. A few hours of attention now could prevent years of financial pain later and keep your retirement on the schedule you deserve.
Navigating the fine print of income protection can be complex, but you don’t have to do it alone. 

At bokis.com.au, we specialise in cutting through the jargon to help you understand your true exposure. Whether you need a comprehensive review of your current default cover or a quote for a tailored retail policy that protects your income to age sixty-five, our team can guide you toward a solution that fits your life and budget. Don't wait for a claim to find out you're under-insured, contact us today to secure your financial future with confidence.