Deborah Wixted discusses the options for terminally ill clients who want to withdraw their superannuation before preservation age.
Since 1 July 2007, a person with a terminal medical condition has been able to withdraw their super benefits, including any insured terminal medical condition benefits, before preservation age.
This article discusses the terminal medical condition definition, the super and tax treatment, and some of the associated issues.
What is a terminal medical condition?
A person has a terminal medical condition if:
- Two medical practitioners certify that the person suffers from an illness, or has incurred an injury, that is likely to result in their death within a specified period within the following 12 months;
- At least one of the medical practitioners is a specialist with respect to the illness or injury; and
- The specified certification period has not ended.
This definition applies for the purposes of:
- Superannuation: a terminal medical condition is a condition of release with no cashing restrictions and allows super benefits to be withdrawn in full as a lump sum and/or an income stream; and
- Taxation: a lump sum terminal medical benefit is not subject to tax, as discussed below.
What is the tax treatment of lump sum terminal medical benefits?
Having a terminal medical condition simply means that the taxable component of any lump sum payment to a person is non-assessable non-exempt income, and is not subject to tax.
Any lump sum benefit paid while a person has a terminal medical condition as defined above is treated as a lump sum terminal medical benefit, and is not subject to tax and cannot be rolled over.
A person with a terminal medical condition wishing to roll over their benefit (eg, to a fund that provides income stream benefits or an anti-detriment payment on death) would need to action the rollover prior to declaring their terminal medical condition.
Alternatively, the benefit could be withdrawn as a tax-free lump sum and then recontributed to another fund.
The above points also apply if the terminal medical condition exists within 90 days of receiving a super lump sum.
What is the tax treatment of income stream terminal medical benefits?
Unlike lump sum terminal medical benefits, income stream terminal medical benefits do not enjoy any concessional tax treatment. If a person chooses to withdraw a terminal medical condition benefit as an income stream, the taxable component of any income stream payments will be taxed according to the person’s age.
So for someone who is under 60, the taxable component of the income stream payments is taxed at their marginal tax rates.
In order to obtain the 15 per cent tax offset on this amount, the benefit must also be a disability super benefit.
This requires the person to have two legally qualified medical practitioners certify that, because of their illness or injury, it is unlikely that the person will ever be gainfully employed in a capacity for which he or she is reasonably qualified because of education, experience or training.
As a terminal medical condition may not render a person unable to work until their illness is quite advanced, this can mean that taking a terminal medical condition benefit as an income stream may not be a client’s most tax-effective option.
Can terminal medical condition income stream payments be paid tax-effectively?
A person suffering from a terminal medical condition may be able to withdraw their superannuation as a tax-free lump sum, and then recontribute all or part of the proceeds as a non-concessional contribution (being mindful of the contribution caps).
This would then result in a super benefit with an increased tax-free component that could be used to commence an income stream with no or reduced tax on payments, regardless of the person’s circumstances.
Note that this strategy may require the person to reconfirm their terminal medical condition to their fund trustee in order to commence an income stream with preserved benefits arising from the recontribution.
A recontribution strategy involving terminal medical condition benefits in this way may be useful to commence an income stream:
- That is paid tax-effectively to the client while they are alive; and
- Is then subject to a reversionary nomination to a surviving spouse, for estate planning purposes.
What is the effect of payment of a terminal medical condition benefit on a client’s estate planning strategies?
A terminal medical condition benefit may be viewed as the early payment of a death benefit that would otherwise be payable on behalf of a client.
A terminally ill client may consider the payment of their benefit as a combination of lump sums and income streams, either as a terminal medical condition benefit while alive or subsequently as a death benefit, in a way that provides the most flexible and tax-effective outcome for them and their family.
As such, consideration should be given to the interaction of both payments, including:
- An insured terminal medical condition benefit may be claimed and paid out of the fund in addition to a terminally ill client’s super account balance, increasing the overall terminal medical condition benefit.
- Payment of a terminal medical condition insurance benefit may reduce or preclude the payment of any death insurance benefits.
- Payment of a client’s entire account balance as a lump sum terminal medical benefit will generally result in no insured death benefit being payable on the client’s death. A sufficient account balance should be maintained to enable the continued payment of insurance premiums and ultimate payment of any death insurance benefits.
- A recontribution strategy undertaken to improve the tax-effectiveness of a terminal medical condition income stream may result in a reduced or no anti-detriment payment.
- Payment of a terminal medical condition benefit may enable a client to pay off debts and make payments to a broad range of potential beneficiaries outside the super death benefit provisions.
Deborah Wixted is head of technical services at CommInsure.