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Understanding super & money
Stuart Sheary Senior Technical Manager
Clients with a terminal medical condition may withdraw all their super benefits as either a lump sum or commence a super income stream regardless of their age. Accessing super under the terminal medical condition of release is one of many planning issues confronting terminally ill clients. Accessing super under this condition of release often requires a deep analysis to achieve the most suitable client outcome. The following discusses some of the super options and outcomes for clients with a terminal medical condition.
The definition of a terminal medical condition is identical under both super and tax law. This means the same criteria applies for satisfying the condition of release to withdraw from super as well as having any lump sum payment treated as non-assessable-non-exempt income (NANE) i.e. a tax free payment.
A terminal medical condition is satisfied where:
The taxation of a withdrawal under a terminal medical condition of release depends on whether it is taken as a lump sum or an income stream. Lump sum withdrawals are tax free whereas taxation on any income stream is based on the age of the member and tax components.
There are no special tax concessions on income streams commenced under this condition of release and payments are taxed according to the table below:
*Tax-free components are tax-free regardless of age
Two registered medical practitioners must certify that the member’s medical condition is likely to result in death within a period not exceeding 24 months.
This period in which the member is likely to pass away is known as the certification period. Super release forms under this condition of release ordinarily ask the medical practitioner to declare that the member will likely pass away in the next 24 months. It is possible that the medical practitioner certifies a shorter period, in which case the certification period might be less than 24 months.
Whilst other conditions of release may be available, the client may prefer to access super under the terminal medical condition of release as lump sum withdrawals are tax free regardless of age.
Clients with a terminal medical condition may re-evaluate the suitability of their existing super fund in the context of their changing circumstances. This may prompt them to consider rolling their funds to new super fund. However, under reg 306.10.01 of the Income Tax Assessment (1997) Regulations 2021, a super lump sum benefit paid to a member having a terminal medical condition is specifically excluded from being a roll-over super benefit.
This means if the trustee is made aware that the client has satisfied a terminal medical condition of release, tax law does not treat this amount as a rollover. However, nothing under super law prevents the funds from being transferred to another fund. As such, any transfer to a new fund during the certification period is treated as a withdrawal from the existing fund and a contribution into the new fund. This may result in an excess non-concessional contribution to the client.
If the client lives beyond the certification period, they can roll their benefits to a new fund once the certification period has expired.
If a client is in an unsuitable fund and wishes to rollover to a new fund they may prefer delaying an application to be assessed under a terminal medical condition of release. Instead, they should consider rolling over to their preferred fund and making an application under a terminal medical condition with their new fund.
Clients should be careful before rolling super to a new fund and consider any implications insofar as loss of benefits such as insurance cover within the fund.
Clients may have insurance cover such as life, terminal illness, and or total and permanent disability (TPD) inside of super.
Clients should not rollover their benefits if it results in forgoing an insurance benefit. Where a client has both life and TPD cover they should be aware of the implications of claiming on one type of cover on the other type of cover particularly if sums insured differ.
Often life insurance carries a terminal illness option allowing clients who are terminally ill to claim on their life cover early. Different policies may have different policy terms. For example, some may require a doctor to certify that the client will pass away in 12 months rather than 24 months. This might mean that a client whose doctors believe that the client will live beyond 12 months, but less than 24 months will satisfy the terminal medical condition of release under super and tax law but fail the insurance terminal illness definition. These clients should generally delay any withdrawal until they are eligible to claim on their insurance.
During the certification period advisers should review the insurances within the client’s super account and ensure there is no loss of cover because of making a withdrawal or rollover from super.
Clients who hold combined life and TPD cover may have a buy back option. Where they also satisfy total and permanent incapacity, they may be able to claim on TPD and if they have a buy back option reinstate their life cover. This would allow the client to claim on both TPD and life cover.
Clients may choose to retain their benefits in super and instead leave a death benefit to their intended beneficiary such as a spouse or child.
There are many reasons a client may not want to release super early under the terminal medical condition of release. One example might be where there is life insurance within the fund that is only paid upon death, i.e. there is no terminally ill option to claim the life insurance early.
If the intended death benefit beneficiary is eligible to receive a death benefit income stream, then leaving funds in super may be the preferred option. Beneficiaries who may receive an income stream include:
Where both the deceased and the beneficiary receiving the income stream are below age 60, the taxable component of the income stream payments is taxable at marginal rates with a 15% non-refundable tax offset. Where either the deceased or the beneficiary is age 60 or more, the death benefit income stream is received tax free.
The table below illustrates the taxation on a death benefit income stream.
Scenario where it may be preferable to leave benefits in super
Nick (62) is diagnosed with a terminal illness. He has a super benefit of $700,000 consisting entirely of taxable component (taxed element).
If Nick dies and these benefits are paid as a death benefit super pension to his spouse (56), the pension’s investment income and death benefit pension payments are tax free. His spouse can access tax free lump sums anytime.
If he takes out the benefit as a terminal medical condition lump sum and his spouse inherits the funds, she may have to invest in her own name and pay tax at her marginal tax rate or re-contribute part of the amount to her super subject to contributions caps and her total superannuation balance.
As an alternative to a death benefit income stream, the client may prefer to leave their intended beneficiary a super lump sum death benefit, either paid directly from the super fund or via the client’s deceased estate.
This option may be preferred where the intended beneficiary has an immediate cash need such as paying off debt or where an income stream is not an option (example adult child beneficiaries).
The taxation on death benefit lump sum amount paid to a beneficiary depends on whether they are a death dependant and tax components of the super payment.
The table below illustrates the taxation on a death benefit lump sum.
If reducing any tax on benefits paid to a non-dependant is a priority, clients may wish to withdraw all their super under the terminal medical condition of release and leave the benefits to their beneficiary via their estate. A cash inheritance paid via the estate to a beneficiary will not be taxed unlike a super death benefit comprising of a taxable component paid to a non-death dependant. Taxable super death benefits paid directly to a non-death dependant can be taxed between 17% and 32% (including Medicare Levy).
A maximum tax rate of 32% applies on any taxable component (untaxed element). An untaxed element is created under section 307.290 of the Income Tax Assessment Act 1997 (ITAA 1997), where a death benefit consists of insurance proceeds for which the fund claimed a deduction (which is common).
Sometimes the client may also satisfy another condition of release such as permanent incapacity. To satisfy this condition of release the super trustee must be satisfied that the client is unlikely to ever engage in gainful employment for which the member is reasonably qualified by education, training or experience (SISR 1.03C).
The tax concessions associated with the permanent incapacity condition of release can make this condition of release an attractive alternative to the terminal medical condition of release particularly where the terminally ill client wishes to commence an income stream.
The tax concessions available where a client satisfies a disability payment under section 995.1 of the ITAA 1997 includes a 15% tax offset on income streams (including where the client is below preservation age). In addition, a tax-free uplift is available on lump sum payments and rollovers.
To obtain the 15% tax offset on a disability income stream or tax-free uplift on a commutation, the client must satisfy the tax law definition under section 995.1 which requires the client to obtain certification from 2 legally qualified medical practitioners that because of the ill-health, it is unlikely that the individual can ever be gainfully employed in a capacity for which he or she is reasonably qualified because of education, experience or training.
Under the terminal medical condition of release, clients below preservation age are not entitled to a 15% tax offset on income streams. The availability of the 15% tax offset under the disability condition of release can make it a more attractive alternative to the terminal medical condition of release if the intention is to receive the member’s benefit as an income stream whilst they are under preservation age.
Clients below age 60 wishing to draw a lump sum will likely prefer taking a tax-free lump sum under the terminal medical condition of release. Lump sum withdrawals under the disability condition of release are taxable depending on the age of the client and components of the fund. However, where a super lump sum is drawn, or an amount rolled to a new fund, the existing fund will apply a tax-free uplift increasing the tax-free component.
Before starting an income stream, it is strongly encouraged to complete a product comparison with alternative funds to ensure they use the most appropriate product. Now may be a good time to find a more competitive product or change to a product that offers necessary features like the ability to commence a death benefit income stream etc. If the client rolls their benefits to a new fund, a tax-free uplift will apply if the transferring fund holds the required certificates, and the subsequent income stream will have a larger tax-free component. This increase in tax-free component can benefit clients under age 60. The increase in tax-free component may also benefit beneficiaries below age 60 wanting to receive the super death benefit as an income stream.
Terminally ill clients may wish to consider a recontribution strategy for the benefit of their intended beneficiaries. A recontribution strategy involves withdrawing a tax-free lump sum under the terminal medical condition of release then recontributing back into super as a non-concessional contribution. This has the potential to convert a taxable component within the fund into a tax-free component.
An increase in the tax-free component may benefit a spouse below age 60 wishing to receive a death benefit income stream or alternatively save a non-benefit dependant such as an adult child tax on a super death benefit lump sum.
Clients with a terminal medical condition who receive a social security benefit may prefer to retain super in accumulation phase. Super in accumulation phase is not assessed for social security purposes until the client attains age pension age.
Impacted clients may consider limiting any lump sum withdrawal to amounts necessary to repaying debts or implement a re-contribution strategy.
Where a death benefit is to paid to a deceased client’s beneficiary it is important to remember that death benefits cannot be rolled into the beneficiary’s accumulation account and must be drawn as a lump sum or a death benefit income steam. If the intended beneficiary is in receipt of social security, then a withdrawal under terminal medical condition of release and contribution into the spouse’s super fund may also be a consideration.
Clients with a terminal medical condition often have a lot of planning issues including areas concerning their finances and super. Advisers can provide significant value during this stressful period by guiding clients through these areas. Accessing super under the terminal medical condition of release is one of many planning issues which often requires a deep analysis to achieve the most suitable client outcome.
If you have any questions, or would like more information, please contact the IOOF TechConnect team on 1300 650 414.
This article is provided 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 as part of the group of companies comprising IOOF Holdings Ltd ABN 49 100 103 722 and its related bodies corporate (‘IOOF Group’).
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