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Self Managed Super Fund (SMSF) Article
Super & Death Benefits

By Tony Negline.

This article may be out of date.

26th March 2007

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A Superannuation benefit paid today can contain up to eight components. Each has its own qualification and tax rules. Some components have sub-components. It is all rather complicated.

Fortunately, from July 1, 2007 these spaghetti and meatball rules will be replaced by just two components: taxable, and tax-free.

Clearly some conversion process must take place, so it's important to understand the translation methodology. In some cases, particularly with pensions to those under 60, careful number crunching will be required to ensure there are no unintended consequences.

Under the current rules, the pre-July 1983 component (that is, the portion of a benefit that relates to the time before July 1, 1983) and the post June '83 component fluctuate depending on the total number of days in a benefit's service period and also by movements in the market value of a fund's investments. All other components do not fluctuate in this way.

On July 1, 2007, the pre-July '83 component will become part of the tax-free component. All undeducted contributions, small business CGT concession components, post-June '94

invalidity components and concessional components will all become part of the tax-free component.

The post-June '83 component, the excessive component and the very uncommon qualifying component will become part of the taxable component.

For someone with non-pension benefits in a super fund this is a relatively simple exercise.

Suppose a person started work in June 1977 and in July this year will have $200,000 in super assets. Of this amount, $20,000 would be undeducted contributions. Without going into any detail, on July 1, 2007, the pre-July '83 component will be about $20,000, which means the post-June '83 component will be the balance of the benefit -- that is, $160,000.

This means the tax-free component will be $40,000, or 20 per cent of the benefit and the taxable component will be $160,000.

From July 2007, if any of this benefit is taken, then 20 per cent of the benefit will be taxfree. It is not possible to nominate taking a benefit solely with tax-free or taxable components.

The remainder may be taxed if it is paid before the member turns 60. This percentage then stays with this benefit. If the fund member used this money to take a pension before turning 60 then 20 per cent of each pension payment would be tax-free.

The rest would be taxed at marginal rates less a 15 per cent rebate.

Once the investor turns 60, the pension payments become tax-free. When the member dies, 20 per cent of the account balance will paid out tax-free, if paid as a lump sum.

The remaining 80 per cent will also be tax-free, if it is paid to a dependant. If paid to a nondependant (such as an adult child) then the taxable component is taxed at 16.5 per cent (including the Medicare Levy).

Some media reports claim that this is some kind of new "death tax". It is nothing of the sort. This has been the rule since July 1994.

Under current rules non-dependants could elect to take the death benefit as a pension.

This potentially produces a tax benefit, but most non-dependants like to take most of these benefits as lump sums so they can repay debt or school fees.

If the benefit is taken as a lump sum then current rules tax the non-dependant at 16.5 per cent up to the deceased's pension reasonable benefit limit. Beyond that 46.5 per cent tax applies.

How do we calculate the tax-free and taxable components for pensions being paid before July?

There are different rules depending on age. If the pensioner is under 60 on July 1, then the current arrangements will remain in place until the pension is partially or fully commuted or the member turns 60 or dies.

At this point the eight components of the pension will be determined and then moved into the new taxable and tax-free components. The percentage of tax-free will stay with the benefit forever.

Now is someone under 60 better off staying with the current tax system, or moving to the new one? It is very hard to provide any hard and fast rules, as there are so many variables and complex calculations must be done.

If the pensioner is aged at least 60 on July 1, then they will automatically move to new components with effect from that date.

It is very important to realise that with pensions, the undeducted purchase price reduces with each pension payment. Also the post-June '83 service period continues to grow, which means the pre-July '83 component will always be getting smaller.

Finally, it appears that social security benefits, such as the aged pension, will continue to be assessed using the current rules based around life expectancy.

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