Payment of a lump sum disability benefit presents a great opportunity for planners to add value by reducing the taxable component to, potentially, nil.
A lump sum disability payment is generally sourced from a combination of life insurance proceeds (received tax free by the fund) and savings. Unless the member has made non-concessional contributions previously, the member’s benefit will comprise 100% taxable component. When a lump sum disability payment is made, a formula converts some, or all, of the taxable component to tax free component.
The interesting thing is that the formula is applied if a payment is made from an accumulation account, a pension account or, most importantly, if the member rolls over their benefit to another superannuation fund. This presents some opportunities to maximise the tax-free component, particularly if the member wishes to retain their member balance in the superannuation environment and start a pension.
A pension commenced prior to the rollover will not have an increased tax-exempt component so the pension payable from the taxable component will be taxable with a 15% tax offset (if the beneficiary is under age 60). If the member rolls over before starting the pension, the increased tax-free component ensures that part of the pension will be permanently tax free. This provides the additional potential benefit of increasing the tax-exempt component which might, eventually, form part of a death benefit payout to a non-tax dependant.
If a non-concessional contribution is added prior to taking a lump sum, or rolling benefits to another fund, the tax-exempt component grows even more as the formula to determine the additional tax-free component references the member’s total account balance, inclusive of the tax-exempt amount. It’s even possible that the calculated tax-exempt component could be greater than the member’s account balance, in which case it is 100% tax exempt.
Consider this example:
Jack was born 1/1/1980, has an eligible service date of 1/1/2010 and becomes totally and permanently disabled on 1/1/2025. Jack’s superannuation account has $1m in combined savings and insurance proceeds. It is all taxable component.
When Jack draws a lump sum benefit, or rolls to another fund, his taxable component reduces to $428,583. If Jack had made a $360,000 non-concessional contribution just prior, his taxable component would further reduce to $222,872.
We provide our Alliance Partners with a calculator for this analysis as well as a report which might be incorporated into an advice document.
