TPD Insurance in Superannuation: TPD Claims and Tax
Unlike personally owned TPD Insurance policies for which claims are generally paid without a taxation liability, TPD Insurance in superannuation fund (including a SMSF), will incur a taxation liability when that TPD Insurance claim is released from the superannuation fund. TPD Insurance claims under superannuation are classified as “superannuation disability benefits” and are treated in the same manner as a release of accumulated funds for total and permanent disablement.
Under the Superannuation Industry (Supervision) Act 1993, permanent incapacity payments can be made from superannuation when a person has;
“… suffered a physical or mental ill health or injury and two legally qualified medical practitioners certify the person is unlikely to be gainfully employed again in a position for which he or she is reasonably qualified due to education experience or training. A person is gainfully employed where he or she is employed or self-employed for gain in a business, trade, profession, vocation, calling, occupation or employment.”
When holding TPD Insurance in Superannuation, apart from the additional ‘any occupation’ definition hurdle that needs to met firstly to be eligible for claim; TPD claim payments paid as a lump sum from superannuation attract a taxation liability. Determining the liability of taxation can be difficult as the rates of taxation are dependent on the ‘components’ of the superannuation fund, the age when disabled and the number of days until retirement.
In any case the following rates of taxation (inc. Medicare Levy*) apply to TPD Insurance in superannuation when a lump sum payment is made from the superannuation fund;
If under preservation age;
- Taxable Component (Taxed Element) – 21.5%*
- Taxable Component (Untaxed Element) – First $1.205m – 31.5%, thereafter 46.5%*
Preservation age to age 59;
- Taxable Component (Taxed Element) – first $165,000 – 0%, thereafter 16.5%*
- Taxable Component (Untaxed Element) – First $1.205m – 16.5%, thereafter 31.5%*
Over the age of 60;
- Taxable Component (Taxed Element) – 0%
- Taxable Component (Untaxed Element) – First $1.205m – 16.5%, thereafter 46.5%*
*The Government has announced as part of the 2013/14 Federal Budget an increase to the Medicare Levy from 1.5% to 2% from 1st July 2014. As such the tax rates above will increase by 0.5%.
Working out what the potential dollar value of any taxation liability of TPD claims from superannuation is complicated. Any accumulated investment balance is added to the insurance benefit and the TPD tax is applied on the full combined amount. In addition, the TPD insurance benefit amount is proportionally split between the different components dependant on the claimant’s age and time until retirement. What makes determining the dollar value most difficult is that apart from the rates of taxation, being a day based calculation, the actual TPD tax liability changes every day!
Let’s look at an example;
John who is aged 42 (DOB 01/01/1970), suffers an injury whilst renovating his home on the 20/06/2012. John is deemed totally and permanently disabled on that day and meets a condition of release. John has an eligible service date of 01/01/2000, has $120,000 accumulated in his superannuation fund and has a bundled Life and TPD Insurance policy for $500,000. John’s entire accumulated superannuation balance is a taxable component (taxed element). John’s net of taxation permanent incapacity payment would be determined as follows;
1. Days from Date of Disability to Date of Retirement (Age 65) (A) – 8231 days
2. Service Start Date to Date of retirement (B) – 12,785 days
3. % of tax free component = No of days in (A) divided by number of days in (B) X 100 = 64.38%
4. Tax free component = % of tax free component x benefit amount = $399,156
5. Taxable component = Benefit amount – Tax free component = $220,844
6. Tax payable = Taxable component x 21.5% = $220,844 x 21.5% = $47,481
The net amount that would be payable to John would be $620,000 – $47,481 = $572,519
The example above is somewhat a relatively simple calculation as John’s superannuation balance is formed entirely by the taxed element of the taxable component. If there were any other components, the calculation would be determined differently.
What would happen if John was budgeting to receive $620,000 to pay off debt, fund medical/rehabilitation expenses? In this case, John’s payment may fall short of his requirements adding financial burden to an already difficult situation where John believed he was fully covered!
What happens to the Life Insurance in Superannuation?
In the example above, John had $500,000 Life Cover bundled with TPD Insurance. It is common for superannuation funds to combine Life and TPD insurance. When a claim for TPD Insurance is made and funds released from superannuation, the Life Insurance policy will also cease, leaving the claimant uninsured for death/terminal illness.
Unless additional coverage has been sought outside of cover prior to claim, if continued life insurance is required, a new policy will need to be applied for with full medical underwriting. In these circumstances it can be difficult to re-obtain coverage given there has been a substantial change in health.
Should I take TPD Insurance in Superannuation?
In general, insurance in superannuation can provide a cost and tax effective way of insuring against death and disability. In most circumstances however, the tax saved by insuring in superannuation is dwarfed by the liability that arises from a claim.
Care needs to be given when insuring in superannuation to ensure that net of any taxation liability, the payment made will be enough to cover ongoing needs. A common method of insuring via superannuation is to ‘gross up’ the benefit to cover any taxation liability. Calculations can be difficult and advice is paramount to ensure that superannuation provides the most effective way of protecting a family against the total disablement of its members.
Lastly, thought needs to be given the possible impact of a TPD claim on ongoing life insurance and if it is envisaged that life insurance will be required after a TPD insurance claim, alternative arrangements may need to be sought if the superannuation fund does not offer separated coverage.
Although tax levied on TPD Insurance in Superannuation is almost certain, there are a number of strategies available to reduce potential tax liabilities. The advisers at Primoris Financial can assist you manage your TPD Insurance claim in a tax effective manner to assist your funds last longer. Contact Primoris Financial today for a cost and obligation free initial consultation to discuss your options.
Questions? Email Primoris Financial here
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