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What are the implications for a claimant upon receiving a Total and Permanent Disability (TPD) benefit paid from superannuation? One of these is the potential for a tax liability when the benefit is paid as a lump sum.
Why TPD in super
Premium affordability is often the key motivator that attracts individuals to place their TPD insurance via superannuation. Premiums can be paid from existing superannuation savings, non-concessional contributions, salary sacrifice arrangement in the case of employees, or tax-deductible contributions by the self-employed. This allows TPD insurance to be put in place with little if any impact on an individual’s cash flow.
However, it is important to know that whilst premium affordability and cash flow issues can be addressed by taking TPD cover in super there is potentially a tax liability that you will incur when the benefit is paid.
A TPD benefit inside super may be received by you as a lump sum or income stream. If you also satisfy the definition of a disability super benefit, he or she can qualify for an additional tax-free amount on a lump sum benefit paid under the age of 60 to reflect the future period the individual would have been expected to work. This amount is added to the existing tax-free component of any accumulated super savings. The amount of tax paid depends upon the age of the member. If the member is under age 55, then a portion of the benefit will be tax free, while the remaining portion will be taxed at up to 21.5% (including Medicare Levy). If the member is between age 55 and 59, then a portion will also be tax free, and the taxable portion above a low-rate threshold (currently $175,0001) will be taxed at 16.5%. If however, the member is over age 60, then no tax will be paid.
Case Study: Scott – $500,000 TPD lump sum benefit
Date of birth | 1/01/1960 |
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Date of initial service | 11/04/2008 |
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Date of TPD | 11/04/2014 |
| Service Days = 2,191 |
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Expected retirement date | 31/12/2024 |
| Days to Retirement = 3,917 |
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TPD Component |
| Amount |
| Tax Liability |
| Net Payment | |
Tax free |
| $500,000 x (3,917) |
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| (3,917 + 2,191) |
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| Nil |
| $320,652 |
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| = $320,652 |
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Taxable |
| $500,000 – $320,652 | $179,348 x 21.5% |
| $140,788 | ||
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| = $179,348 |
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| = $38,560 |
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Total |
| $500,000 |
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| $38,560 |
| $461,440 |
In the worst-case scenario, the member pays 1/6th of their TPD benefit to the Australian Taxation Office. For a client depending upon the sum insured to eliminate debts and pay medical bills, this tax burden may be an unwelcome surprise.
Note that the additional tax-free amount is calculated each time a disability lump sum amount is withdrawn and the calculation only relates to the amount withdrawn. As time progresses, the number of “Service Days” increases and this has the effect of producing a smaller additional amount of the benefit which is being treated as tax free.
As an alternative, when a member of super fund suffers a permanent incapacity (TPD), they may choose to take a pension in lieu of a lump sum. The taxable component of ongoing pension payments (subject to the minimum payment standards) is taxed at the recipient’s (the member’s) marginal tax rate (less 15% tax offset) until the member’s 60th birthday, after which the entire payment is tax-free.
Summary
Although tax deductibility of premiums within superannuation is attractive, it is important that you are aware of the potential tax bill when the benefit is paid as a lump sum. To avoid this, keeping the insurance outside of super affords certainty that the sum insured is the exact amount you will receive at claim time.
