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Self Managed Super Fund (SMSF) Article
Anti-detriment rules for death benefits

By Tony Negline.

This article may be out of date.

12th December 2007

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When super funds were first taxed almost twenty years ago the Hawke Government's Treasurer, Paul Keating, had to lessen the negative political impact of these unpopular changes.  He decided that taxpayers adversely impacted by the tax on contributions should be fully compensated.

Logically these concessions should probably have been removed when Peter Costello rewrote most of the super tax laws as part of his 2006 super reforms.  Happily some of Keating's concessions have survived.

One of them involves particular lump sum death benefits.  The rule attempts to return a death benefit to a position in which it would have been if a fund did not have to pay contributions tax.  The net result is that death benefits can be increased because of a tax refund.

A number of steps have to be followed before being allowed to use this rule.

Firstly, the death benefit must have been paid as a lump sum.

Secondly some or all of the death benefit must have come partly from contributions.  If the death benefit comes solely from insurance proceeds then the concession is unavailable.

Thirdly the concession is only available if it is to be paid by a super fund trustee to the deceased's spouse, former spouse or children.  Currently same sex-couples are excluded from this definition even though under other super laws they may be eligible to receive death benefits and under other tax rules may not face any tax on a super fund death benefit.

At face value the return of the tax occurs in an unusual way and it is here that many Self Managed Super Funds come unstuck.  The amount added to the death benefit comes to the super fund via a tax deduction claimed on the fund's tax return.

This means that a fund can only take advantage of this rule if it will be paying income tax on income and gains in the financial years following the payment of the death benefit.  If a fund is not going to pay tax (for example because the remaining members of the fund receive pensions) then it is not possible for the fund to refund the contributions tax with the death benefit and the additional death benefit is not available.  If the fund is going to be wound up after the payment of the death benefit then the concession will only be available if the tax deduction can be fully offset on the fund's final tax return.

An added problem for SMSFs is working out the best way to fund the additional death benefit.  As the tax office refunds the additional benefit via lower tax payments it may be some years before all the excess tax payments are returned to a fund.  How will the SMSF fund this additional benefit especially if all the assets of the fund are allocated to particular members?  This is a particularly tricky issue if the death benefit is not being paid to a surviving fund member.

There are various ways of working out the concession.  The first option simply asks a fund trustee to work out what the benefit would have been if contributions tax had not been collected.  In the majority of cases this is an impossible number to calculate as most funds do not track the impact of tax on a member's account balance over their membership.  Also if a member has transferred any super benefits from other superannuation funds then the details of the benefits transferred never include the actual effect of contributions tax.

Fortunately the tax office has developed a formula which most funds will use.  Firstly we work out the number of days between 1 July 1988 and the date of death.  We multiply this result by 0.15.  For example suppose Bill Jones joined a fund on 1 March 1990 and died on 1 January 2008.  Step one would therefore be 977.25.

Step 2: next we work out the total service days relating to the death benefit which occured after 30 June 1983.  We take this number and subtract from it the result of Step 1.  In our case would be 5537.75.

Our third step involves dividing step one by step two.  In our example this produces 0.1765.

Finally we take the number worked out in step three and multiply it by the death benefit less any amount of insurance.  If our Bill Jones had $1,000,000 in his super fund then the result would be $176,500.  This is the tax deduction allowed by the fund.  This means that the death benefit would be increased by $26,475 (15% of the tax deduction allowed).

This formula needs to re-drafted because of Costello's super reforms but for now the ATO has said we can use it.

Sadly not many SMSFs have taken advantage of this rule simply because the fund's advisers have not known about it.

Most large funds have known about this rule for many years but regrettably have not implemented it because other priorities have taken precedence.  Running a large fund is complex and there are no pats-on-the-back from the regulators or industry prizes for being tax efficient.

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