Total and permanent disablement payments through super
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.
Accessing a TPD benefit through super
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.
Form of a TPD benefit
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.
Tax on a disability benefit
Disability superannuation benefits can be paid to a member as a lump sum or income stream and the relevant tax implications are summarised below:
|Age||Component||Tax on lump sum||Tax on income stream payments|
|Age 60 or over||Total benefit||Nil||Nil|
|Under preservation age||Tax-free||Nil||Nil|
|Taxable – taxed||20% *||Marginal tax rate less 15% tax offset|
|Between preservation age and age 60||Tax-free||Nil||Nil|
|Taxable – taxed||First $225,000 Nil (2021/2022 FY)||Marginal tax rate less 15% tax offset|
|Tech tip: Watch out for the addition of the taxable component of a super lump sum or income stream to assessable income if your client is under age 60 as the outcome could impact their entitlements or obligations related to income (for example, family tax benefits, co-contribution, child support obligations and division 293 tax).|
The lump sum option
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:
|Amount of benefit||X|| days to retirement
(service days + days to retirement)
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)
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.
|Tech tip: When including TPD insurance within super, you may want to select a fund with a later start date to increase the future service period and increase the tax-free component.|
The income stream option
Example – income stream option
Retain funds in super option
Comparing the options
|Retain funds in super||