Financial advisers may be unaware of the hidden costs with regards to the taxation treatment of lump sum benefits from superannuation, according to Damian Hearn.
The taxation treatment of lump sum benefits from superannuation is widely understood and taken into account when advising clients.
However, financial advisers may be unaware of the hidden costs which can result in a client losing Government assistance payments and paying more personal income tax.
When financial advisers speak to clients about lump sum benefits from superannuation, the amount of tax payable (if any) is calculated and taken into account.
However, it is not widely known that the taxable component of a lump sum benefit (including a lump sum death benefit paid to non-death benefits dependants) is included within the client’s taxation return as assessable income for the financial year in which the benefit is received.
The full extent of the true costs becomes apparent when the client’s tax return is completed and lodged with the Australian Taxation Office.
Playing a proactive role in the lump sum death benefit paid in the case study below demonstrates one method which ensures sufficient cash reserves to repay Government assistance payments and pay additional taxes and levies.
Case study: Mike and Alicia
Mike (age 39) worked full time for the 2010-2011 financial year and he earned $61,000. Alicia (age 34) worked one day per week and she earned $7,680.
Mike and Alicia have two children, Ben (age 9) and Emma (age 6), who are in primary school. Alicia had their third child, a baby girl, in July 2011. Alicia ensured she satisfied the eligibility criteria for the new paid parental leave scheme by working one day per week across the 2010-2011 financial year.
Alicia’s mother passed away in December 2010 and her superannuation account of $210,000 was paid as a lump sum death benefit to Alicia. Even though Alicia had a close relationship with her mother, she is classified as a non-death benefits dependant for taxation purposes.
The lump sum death benefit was received by Alicia in May 2011 and comprised a taxable component of $210,000 (with no tax-free component).
Mike and Alicia might want to retain a cash reserve of at least $15,000 to pay for the additional costs outlined below.
What impact will this have on Mike and Alicia’s situation?
The taxable component of the lump sum death benefit ($210,000) will be classified as assessable income for taxation purposes for the 2010-2011 financial year. Consequently, this will have an impact on Alicia and Mike’s personal situation (as summarised within the following table).
The additional costs will reduce the lump sum death benefit to $159,935. These additional costs add a further 7.34 per cent of transaction costs to the lump sum withdrawal. As a combined amount, the total transaction costs are 23.84 per cent as a percentage of the gross lump sum benefit.
The following information outlines the detailed analysis of table 1.
Family Assistance payments
Mike and Alicia claimed family assistance payments for their two children, Ben and Emma for the 2010-2011 financial year.
Impact: Alicia’s adjusted taxable income for Family Tax Benefit purposes will increase to $278,680. Mike and Alicia will need to repay $5,840.36 in family assistance payments.
Parental Leave Payment Scheme
Alicia satisfies the eligibility criteria for the new parental leave payment scheme during the 2010-2011 financial year and she is planning to claim the payment from September 2011.
Impact: The lump sum death benefit increases Alicia’s adjusted taxable income to $217,680 for the 2010-2011 financial year, and this will exceed the limit of $150,000 or less in the financial year prior to the date of the birth. Alicia will not receive parental leave payment scheme payments of $10,609.20 ($589.40 per week over the 18 week period).
The baby bonus of $5,437 will be payable if Mike and Alicia’s estimated combined adjusted taxable income is $75,000 or less in the six months following the birth of their child.
Mike and Alicia’s combined adjusted taxable income for this period within the 2011-2012 financial year will be less than the $75,000 income threshold ($61,000 x 50 per cent = $30,500).
Taxation
Medicare Levy
Normally, Alicia’s employment income of $7,680 for the 2010-2011 financial year would not be subject to the Medicare levy.
Impact: Alicia’s taxable income for Medicare levy purposes will increase to $217,680. This means Alicia will pay the Medicare levy of $115.20 on her employment income ($7,680 x 1.5%).
Medical levy surcharge
Mike and Alicia did not have private health insurance with private patient hospital cover for the 2010-2011 financial year. The lump sum death benefit will be included within Alicia’s assessable income for surcharge purposes. Mike and Alicia’s combined income for surcharge purposes for 2010-2011 is $278,680.
Impact: Both Alicia and Mike will be subject to the Medicare levy surcharge. Mike will pay $610 (1% x $61,000), whilst Alicia will pay $2,176.80 (1% x $217,680).
Low income tax offset
The inclusion of the lump sum death benefit within Alicia’s taxable income for the 2010-2011 financial year means the low income tax offset will not apply.
Impact: The low income tax offset will reduce from $1,500 to nil, and Alicia will pay personal income tax of $7,680 on her employment income. In dollar terms, Alicia will be required to pay $252 ($7,680 – $6,000 x 15%, assuming no other deductible expenses or tax offsets).
Summary
Financial advisers need to be aware of the full impact that lump sum benefits from superannuation can have on a client’s overall financial situation when they are under age 60. It is essential to include appropriate disclaimers within your statements of advice and ensure the client seeks taxation advice from a registered tax agent.
The most important issue is to play a proactive role to ensure you manage your client’s expectations and highlight the impact that the lump sum benefit could have on their overall financial situation.
Damian Hearn is the technical services manager at IOOF.
