While starting an income stream may seem the logical choice for a superannuation member who satisfies a permanent incapacity condition of release, making the decision to roll the benefit over to a self-managed superannuation fund (SMSF), then commencing an income stream may provide you with more benefits, including the creation of a greater tax-free component of the benefit.
Case Study
Richard, aged 40, suffers serious injuries in a motor vehicle accident, and is no longer capable of gainful employment from 1 July 2011.
Two qualified medical practitioners certify it is unlikely Richard will ever be gainfully employed in a capacity for which he is reasonably qualified.
Richard has $100,000 in a retail super fund (all a taxable component).
Richard’s retail super fund maintained a $500,000 life/total and permanent disability (TPD) policy.
The underwriters are satisfied Richard is totally and permanently incapacitated.
The policy pays $500,000 TPD benefit to the fund.
Richard’s date of birth is 1 January 1971.
Richard’s service period started on 1 January 1991.
"Permanent incapacity" is a condition of release with a nil cashing restriction. It is defined as ill health (whether physical or mental) where the trustee is reasonably satisfied that the member is unlikely – because of the ill health – to engage in gainful employment for which the member is reasonably qualified by education, training or experience. So subject to the provisions in the fund’s trust deed, Richard can access his benefit ($600,000 consisting of his member balance of $100,000 and $500,000 TPD proceeds).
If Richard starts an income stream from the retail super fund, it will be a commutable account based pension. As the benefit is a disability superannuation benefit, Richard is entitled to a tax offset equal to 15 per cent of the income from the taxable component of the benefit. The disability superannuation benefit (income stream) will comprise wholly of a taxable component (ie, the total $600,000).
However, if Richard was to roll the benefit over to another superannuation fund – eg, his own SMSF – and then commence a superannuation income stream, a tax-free component is created by the following calculation:
So in Richard’s situation the calculation to modify the benefit and create a tax-free component is as follows:
Benefit details
Amount of superannuation lump sum payment = $600,000
Existing tax-free component of superannuation lump sum = $0
Service Period start date = 1/01/1991
Date member stopped being capable of being gainfully employed = 1/07/2011
Date of normal retirement (usually 65th birthday) = 1/01/2036
Calculation
Days from ceasing gainful employment to normal retirement = 8,951
Days from start date to normal retirement = 16,437
Therefore $600,000 x 8,951/(16,437) creates a tax-free component due to disability = $326,738.46
Components of disability superannuation benefit
Tax-free component $326,738.46
Taxable component $273,261.54
Total = $600,000.00
Richard could now start a superannuation income stream from his SMSF. Again, it will be a commutable account based pension. But due to the modification for a disability superannuation benefit, a large tax-free component is created and would be received by Richard free of tax, if part of an income stream. The pension income attributable to the taxable portion of the income stream would be entitled to a 15 per cent tax offset.
The same calculation for the creation of a tax-free component would apply if Richard decided to take the benefit from the retail fund as a lump sum. The lump sum tax on the taxable component would be levied at the rate of 21.5 per cent as Richard is under preservation age. However, no lump sum tax would be payable on rollover to a new fund to start an income stream and the assets used to pay an income stream are also exempt from tax. As Richard has satisfied a condition of release, he has no cashing restrictions regarding his pension (ie, it is fully commutable). Furthermore, if Richard has no tax dependants, the created tax-free component will reduce any lump sum tax payable upon his death by his beneficiaries.
Nick Ali is a technical services specialist at Super Concepts.
