Understanding financial advice
Financial life goals
Tools and resources
Products and services
Investing with IOOF
Your retirement goals
By Mark Gleeson, Senior Technical Services Manager
As most advisers may not provide advice on managing total & permanent disablement (TPD) payments often, here is a refresher to ensure your knowledge is up to date. We explore lump sum payments, income streams and other options to maximise social security payments.
To access a TPD payment from a super fund, your client must initially satisfy the insurance policy definition. If their policy was in place before 1 July 2014, the TPD definition could vary from the current definitions. For example, the policy may have an ‘own occupation’ definition, ‘homemaker’ definition or a modified TPD definition. If the policy definition is satisfied, the proceeds are paid from the insurer and added to the client’s superannuation balance but will not be treated as a super contribution. At this point, the insurance proceeds increase the taxable component.
To access money as a lump sum or income stream, the permanent incapacity condition of release or other condition of release must be satisfied. Permanent incapacity occurs when a client has physical or mental ill-health, and the trustee is reasonably satisfied that they are unlikely to engage in gainful employment for which they are reasonably qualified by education, training or experience. The fund trustee generally requests medical certification from two legally qualified medical practitioners when making an assessment.
When the permanent incapacity definition is satisfied, the amount in the super fund becomes an unrestricted non-preserved component. This simply means that the funds can be accessed as a lump sum, income stream, or a combination of both. Your client can leave the funds in the accumulation phase of super indefinitely.
Many clients only consider taking the lump sum, but it is important to assess other strategies that are more tax-effective or which may increase social security payments.
Disability superannuation benefits can be paid to a member as a lump sum or income stream and the relevant tax implications are summarised below:
* Plus 2% Medicare levy where applicable
There is an additional tax concession provided to a lump sum or rollover, known as a disability super benefit.
The tax-free component is increased if the benefit is paid because of ill-health and two legally-qualified medical practitioners certify the client is unlikely to be gainfully employed in a position for which he or she is reasonably qualified due to education, experience or training.
The fund trustee must obtain two certificates from qualified medical practitioners to increase the tax-free component. The fund trustee would normally have already requested these details for the permanent incapacity assessment.
The tax-free component of the benefit is increased to broadly reflect the period the client would have expected to be gainfully employed. The existing tax-free amount in the super fund is increased by an amount which is calculated as follows:
Days to retirement: number of days from the day on which the person stopped being capable of being gainfully employed to their last retirement date.
Last retirement date: if a person’s employment or office would have terminated when he or she reached a particular age or completed a particular period of service - the day he or she would reach the age or complete the period of service (as the case may be); or in any other case the day on which he or she would turn 65.
Service days: number of days in the service period for the lump sum.
Any days that are included in both ‘service days’ and ‘days to retirement’ are to be counted only once. More information is available at ATO’s Calculating components of a super benefit.
Example – Lump sum and increased tax-free component
Archana, age 47 (date of birth 23 January 1974), has $100,000 in super (all taxable component) with any occupation TPD cover of $900,000. Archana sustains an injury and triggers the payment of the TPD cover into her super fund.
An amount of $1,000,000 now sits within the account, all as a taxable component. She requests the trustee to release the benefits under permanent incapacity and provides two medical certificates. She wants to receive the full amount as a lump sum and to understand the tax consequences if the date of disability is 1 July 2021.
The start date of Archana’s fund is 11 April 2009. The trustee generally assumes a person would retire at age 65, that is, 23 January 2039 for Archana. After applying the formula above, the trustee calculates the increase in the tax-free component as follows:
$1,000,000 X 6,416 (days to retirement) / 4,464 (service days) + 6,416 (days to retirement)
Days to retirement = 6,416 (1 July 2021 to 23 January 2039)
Service days = 4,464 (11 April 2009 to 1 July 2021)
The remaining amount of the lump sum is $410,295 and is all taxable component (element taxed).
As Archana is under preservation age, the taxable component of $410,295 is added to assessable income and taxed at a maximum rate of 22%. This results in $90,265 tax payable and a net benefit of $909,735.
To reduce Archana’s tax payable, she could consider retaining part of the benefit in the accumulation phase or commencing an income stream. Furthermore, she could rollover the benefit to another provider and request the trustee (of the original fund) to increase the tax-free component.
In hindsight, if Archana required a net lump sum benefit of $1,000,000, the sum insured should have been grossed up to allow for the tax payable.
An account-based pension option paid from the super fund is particularly tax-effective in cases of TPD due to the tax-free earnings within the fund and tax concessions on pension payments.
A client receiving a disability super income stream before reaching their preservation age receives a 15% tax offset on the taxable component of each pension payment. The tax-free component is tax free. From preservation age, the account-based pension is taxed normally.
Example – income stream option
Let’s continue the example of Archana from before. Instead of receiving the full $1,000,000 benefit as a lump sum, Archana decides to take $400,000 to clear debts and commence an income stream with the remaining amount of $600,000 (all taxable component).
The income stream commenced from Archana’s fund is simply an account-based pension. The pension has a minimum payment of 2% for the 2021/2022 financial year (as Archana is under age 65) and the earnings within the account-based pension are tax-free. The taxable component of payments receives a 15% tax offset.
Lump sums can be accessed at any time, with any tax payable being based on the components. The transfer balance cap is not a problem for her as the commencement value is below $1.7 million.
In short, the tax treatment of the account-based pension compares favourably to alternative investments available to Archana.
You and your client will need to consider the transfer balance cap of $1.7 million1 if part or all of the benefit is received as a disability super income stream.
This cap applies on the total amount that is transferred from accumulation to pension phase. When a disability super income stream is commenced, a credit applies in the transfer balance account.
Tech tip: If an account-based pension is commenced from the super fund that received the TPD insurance, the trustee would not increase the tax-free component using the disability super benefit formula.
However, if the super fund is rolled over to another provider, the trustee increases the tax-free component. Clients should identify their preferred income stream provider before commencing an account-based pension.
Caution: contrived arrangements may be considered tax avoidance and multiple rollovers or other unnecessary transactions should be avoided.
Another option upon TPD is to simply leave the funds in accumulation phase where a maximum 15% tax applies on fund earnings. Lump sums can be withdrawn from the unrestricted non-preserved component as needed, mindful of the tax consequences outlined before. Any earnings growth within the fund forms part of the preserved amount.
From a Centrelink perspective, any amount held in the accumulation phase of super is not assessed under the assets test or income test when under Age Pension age. In contrast, the amount in the accumulation phase of super is assessed as an asset and deemed under the income test from Age Pension age.
The favourable assessment below Age Pension age may allow your client to retain some of the money in the accumulation phase of super and apply for the Disability Support Pension, if eligible.
Amounts held in account-based pensions are fully assessed under the assets test. Any new account-based pension commenced from 1 January 2015 is deemed under the income test.
The table below summarises what you need to consider for the strategies we have detailed. In practice, a combination of two or more options may satisfy the client’s objectives.
There are significant advice opportunities for clients who receive a TPD payout into their super fund. Clients may be keen to take a lump sum from super, although the tax payable may be substantial. A lump sum sufficient to satisfy immediate needs can be a good option combined with an account-based pension to provide ongoing income. The transfer balance cap should be considered before commencing an income stream. Retaining some funds in the accumulation phase may assist a client maximise their Disability Support Pension.
1 This assumes the client had no transfer balance cap account prior to 1 July 2021 otherwise their transfer balance cap is between $1,600,000 and $1,700,000.
If you have any questions, or would like more information, please contact the IOOF TechConnect team on 1300 650 414.
The information in this section of the website is intended for financial advisers only and is not to be distributed to clients. It has been prepared on behalf of Australian Executor Trustees Limited ABN 84 007 869 794 AFSL 240023, IOOF Investment Management Limited ABN 53 006 695 021 AFSL 230524, IOOF Investment Services Ltd ABN 80 007 350 405, AFSL 230703 and IOOF Ltd ABN 21 087 649 625 AFSL 230522 based on information that is believed to be accurate and reliable at the time of publication.