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Self Managed Super Fund (SMSF) Article
Death & Taxes

By Tony Negline.

This article may be out of date.

23rd July 2008

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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 have to be.

It will come as no surprise to find out that the taxation of superannuation death, disability and income protection benefits is not without its complications.

There are two areas of interest - one that deals with the taxation implications of a benefit itself.  The second issue is the tax implications within a super fund after it has paid a benefit.

This article looks at the latter issue.

When a death, permanent disablement or income protection benefit is paid, super funds can access two potential tax concessions.  One concession gives a super fund a tax deduction for the probable future service period of the member.  The other aims to return the 15% tax on contributions paid since 1988.

A tax deduction for the future service period of the member is only available in a super fund if the fund’s trustee elects not to claim any insurance premiums as a tax deduction and is calculated using a formula.

This concession can only be claimed for super fund members who are employed at the time a death, permanent disablement or income protection benefit is paid.  This means some people do not satisfy this rule - anyone predominantly self-employed or anyone who is not employed – and a fund cannot access this concession for them.

This particular tax deduction is potentially very powerful and can save a super fund considerable amounts of future tax liabilities.

There are a number of issues which super funds have to consider before implementing it.

Tax deductions only have any value if they can be used which means that the super fund must be earning income or capital gains which are subject to tax.  Typically assessable income in a super fund includes interest, rent and dividends.

If a super fund has no other function than to pay a pension or income stream 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 the fund has achieves very little.

The trustee's election to claim the benefit payment instead of the insurance premiums will apply to future tax years so, going forward, trustees need to have a good view of what they want their fund to achieve.

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 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 in the year this death benefit is paid.  Importantly what happened in past tax years is irrelevant.  This means the following amount is allowed as a tax deduction:

600,000  x   (15 / 25)  = $360,000

The deduction in our example might save a fund some $54,000 in tax (15% of $360,000).  If this deduction creates a tax loss then that loss is carried forward until it is fully used up.

The second tax 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 but now includes former spouses and those deemed to be in inter-dependant relationships.  The Federal Government has proposed expanding this definition further to allow dependants to include same-sex couples.

This super fund tax 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.

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 when the person started work or first personally contributed to super and ending on the member’s last retirement date.

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