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Self Managed Super Fund (SMSF) Article
Ending up even Stevens

By Tony Negline.

This article may be out of date.

25th June 2008

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Anyone who wants to provide adequately for their loved ones needs to know how the super and tax systems can hinder their objectives.

In this article we will look at a couple still many years away from retirement.

James and Mary Stevens have four primary school age children. James is aged 40 and a successful architect. Mary is 41 and runs the house and also helps in James' office.

Their home mortgage, credit card debt and margin loan total about $600,000. Their current lifestyle costs them $110,000 after-tax. Like most younger Australian families their income is barely covering the outgoing expenses especially with recent interest rate rises.

James' income earning capacity should be protected. Unfortunately many people also foolishly ignore what might happen financially if Mary were to die or become disabled either temporarily or permanently.

The Stevens decide that James' life should be insured for $1.5 million and Mary's life for $500,000.

If James died and the life insurance was in his super fund, how should it be paid? Lets assume that in James' super fund he currently has an account balance of $100,000. Of this amount $10,000 are Non-concessional Contributions which will always be paid out of the super system tax-free. If James were to die his super fund trustee would have to distribute $1.6 million.

Most super fund trust deeds allow a death benefit to be paid as a lump sum. A lump sum death benefit paid to any of James' dependents, which include Mary and their children, will be paid tax-free. The $600,000 of debt could be extinguished leaving $1 million to provide the family's income needs. Is this a sufficient amount for the longer-term?

If James died, Mary would need $55,000 income (which is less than their current income needs because they no longer have to feed and clothe James or pay off the mortgage and other interest costs).

If Mary could invest this money and earn $45,000 income per year income (that is about 4.5% return) then she would end up with about $53,000 after paying income tax and receiving the Family Tax Benefit.

In today's higher interest rate environment 4.5% might not seem a particularly difficult return to generate. Inflation increases the cost of living over time. Additionally the costs of living will increase quite quickly as the children get older. Financial market conditions will change and it may become harder to generate the necessary rate of return on a regular basis. Capital will have to be accessed to make up the income difference. As it stands now the $1 million lump sum has to provide the cost of Mary's remaining life.

If Mary wanted to invest any of these assets in something that generates a capital return then she would face Capital Gains Tax in her own name everytime she wanted buy and sell some of these assets.

In reality increasing the amount of insurance or considering other alternatives should be considered.

We could pay a lump sum to Mary of $600,000 tax-free out of super which would pay off the outstanding debt. Again we have $1 million to allocate.

We could give Mary an account based income stream from her super fund. On the income paid she would pay marginal tax rates less a 15% rebate. This rebate would be paid until she turned 60 at which point income would become tax-free.

The super fund would have to pay her a minimum income of 4% of the account balance. In the first year this would be $40,000.

Because of the 15% rebate and the Family Tax Benefit, Mary would have an income of about $56,000 which is enough to provide for the family right now.

Whilst the children remain dependents, Mary could pay herself an income of $95,000 from the super fund before paying any income tax because of the tax concessions available to her whilst the children are under 18 and don't have any income of their own.

The super route has given Mary her desired level of income for less outlay because of the tax concessions available.

There is an additional advantage with the superannuation approach. Super fund assets used to pay a pension are not taxed. This means that any asset growth is not subject to CGT.

If Mary wanted to take a lump sum out of the super fund once the death benefit income stream started how would this be taxed? Under normal rules it is possible to take a lump sum out of super income streams. If the lump sum were taken before the later of six months of death or three months of the granting of probate or letters of administration then the lump sum would still be considered a death benefit and would be tax free. Lump sums paid after this period are taxed like normal super fund benefits.

Suppose James was concerned about Mary's ability to manage money as it had a tendency to burn a whole in her pocket. How could he protect her from herself and ban the taking of lump sums? This could be a specific provision of the super fund trust deed and the trust deed could also say that this provision cannot be amended.

Finally it is also possible to pay the Stevens' children income streams whilst they are under 25. Once they turn 25 the income stream must stop. If a lump sum is paid at this point then it will be tax-free.

Pre-retiree death benefits

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