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Self Managed Super Fund (SMSF) Article
Death & Super Fund Taxes
By Tony Negline.
This article may be out of date.
7th July 2004
All super funds have to plan for the death of a member.
Without this planning important tax concessions can be lost and ongoing super fund taxes will probably be higher than they need to be.
It will come as no surprise to find out that the taxation of superannuation death benefits is not without its complications.
There are two areas of interest - one that deals with the taxation implications of the benefit itself. The second issue is the tax implications within a super fund itself having paid a death benefit.
This article looks at the latter issue – that is, the tax implications within a super fund of death benefit payments.
When a death benefit is paid there are two potential tax concessions available for super funds. One concession gives a super fund a tax deduction for the potential future service period of the member. The other aims to return the 15% tax on contributions paid since 1988.
A tax deduction for the potential future service period of the member is only available in a super fund if a fund’s trustee elects not to claim any death insurance premiums as a tax deduction. The deduction for the potential future service period is calculated using the formula in the attached table.
This concession can only be claimed for super fund members who are employed at the time of death. This means some people do not satisfy this rule - anyone predominantly self-employed or anyone who is not employed at the time of death.
This particular tax deduction is potentially very powerful. It is available when a death benefit is payable or a disability benefit is payable.
There are a number of issues which super funds have to consider before implementing it.
Tax deductions are only relevant if they can be used and they will only be used if there is income which is subject to super fund income tax. Typically assessable income in a super fund occurs because of income, such as interest, rent and dividends. If a super fund has no other function than to pay a pension then typically the income and capital gains generated from the assets backing that pension will not be taxed and as a result any tax deductions achieve very little.
However the deduction in our example might save a fund some $54,000 in tax. If this deduction creates a tax loss then that loss is carried forward until it is fully used up.
The second concession is only payable when a death benefit is paid to a dependant. Until recently a dependant had to be a deceased’s current spouse and any of the deceased’s children. Amendments have recently been enacted that widen this definition to include former spouses and inter-dependant relationships.
This concession seeks to return any tax on contributions which a fund has deducted from a member’s account and is only available if the trustee pays this tax to the deceased’s dependants as part of the death benefit.
There are two ways for a trustee to work out how the amount of the concession. The first way, and for Self Managed Super Funds, the most common way, is to ask the fund’s auditor to certify what contributions had super fund tax deducted.
The second method is used when it is hard to work out what contributions have been made. This method uses a formula established by the Australian Taxation Office.
Future Service Period Deduction
Deduction = Death or Disability Benefit x (Days in future service period / Days in total service period)
Death or disability benefit:
- a payment to a dependant (this might be a lump sum payment or the lump sum equivalent of a pension)
- the net present value of a pension paid to the member as a result of their permanent disability
- the income paid to a member who is unable to perform his or her normal employment duties (this benefit must be paid for no more than 2 years from when it is first paid).
Days in future service period is the number of whole days in the period from the date employment was terminated and ending on the member’s last retirement date. (For most people the last retirement date will be date the member turns 65.)
Days in total service period is the number of whole days in the period commencing at the person’s eligible start date and ending on the member’s last retirement date.
Let’s look at an example of a SMSF where Bill, a 50 year old member has died. Assume that he had been in the SMSF for about 10 years prior to his death. The fund had an insurance policy of $400,000 on the life of the member which costs $3,000 per year. Assume the Bill’s accumulated benefit in the fund is $200,000. The fund’s trustee intends to pays the deceased’s dependants $600,000. The trustee decides to make an election not to claim the $3,000 as a deduction. This means the following amount is allowed as a tax deduction: 600,000 x (15/25) = $360,000
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