How to protect your client's TPD money
8th Jun 2017
Once your client’s Total and Permanent Disability (TPD) super claim has been accepted and paid into their super account, they will probably withdraw their entire balance. This may result in the member paying thousands of dollars in tax unnecessarily.
There are simple strategies that can be implemented to make the most of any TPD claim, particularly minimising tax payments and maximising other benefit entitlements.
For example, if a member’s TPD and superannuation balance is as low as $50,000, they will pay a lump sum withdrawal tax on average of approximately $5,000, which potentially could be eliminated by applying the right strategies.
TPD through superannuation
When a group TPD insurance claim is approved, the sum insured is usually paid into the member’s superannuation account, giving them the choice to:
- withdraw the entire balance;
- make a partial withdrawal and leave the balance in super;
- commence an income stream (with all, or a portion of, their balance); or
- leave the entire balance in super.
Each option will lead to very different tax and Centrelink outcomes. In taking option 1 or 2, the claimant will pay ‘superannuation lump sum withdrawal tax’. Under option 3, the taxable component of the annual income drawn will be taxable at the claimant’s marginal tax rate, with a 15% tax offset.
Lump sum withdrawal from super
Under options 1 and 2 above, when superannuation is withdrawn before a member reaches preservation age (between 56 and 60), they pay superannuation lump sum withdrawal tax on the ‘taxable component’ at a rate of 22% (based on tax and Medicare rates during the 2016-17 financial year).
When a person is withdrawing super funds under the ‘permanent incapacity’ condition of release, the superannuation trustee completes a calculation to reduce the amount of tax the member will pay, called a ‘tax-free uplift’ calculation.
This calculation is different for everyone, and if a person has multiple funds, the calculation will be different for each superannuation fund they make a withdrawal from.
If the member has minimal or no other taxable income for the financial year then they may be entitled to a partial tax refund. This can mean deferring a portion of the withdrawal to a later financial year and lead to significant tax savings.
TPD insurance claimants need to be vigilant when consolidating superannuation funds. Rolling over a super fund into another fund (even if it is only $100) may change the ‘eligible service date’ of the member’s superannuation fund and thus mean that the member pays a higher lump sum withdrawal tax rate. Advise caution if your clients are considering consolidating super funds!
Commencing an income stream or account-based pension
Under option 3 above, the member has the option to start an income stream with a portion of their entire superannuation fund.
Usually, at retirement a superannuation member will convert their superannuation account into an income stream known as an account-based pension or allocated pension. Members who meet the TPD definition have the same ability to commence a superannuation income stream. However, the income drawn is taxable if the member is under age 60. This means that the member pays PAYG tax on the income drawn on the taxable component of the income stream with a 15% tax offset.
Assuming the member has no other assessable income, this option may mean that the member can draw a significant income (either monthly, quarterly or annually) and pay minimal or no tax.
Different Centrelink benefits will apply different means testing. If you make a lump sum superannuation withdrawal, this is not treated as income under the Centrelink income test for certain pension payments (for example, the Disability Support Pension).
However, the taxable component of a super withdrawal is included in a person’s ‘adjusted taxable income’. This may affect a member’s Family Tax Benefits and certain other payments.
Superannuation is exempt from Centrelink means testing while a person is under their Age Pension Age (between age 65 and 67). Commencing an income stream will mean the account balance will become assessable under Centrelink’s assets test and the balance will be deemed for income test purposes (Centrelink apply a ‘deeming calculation’ to financial assets to work out the income attributed to the asset under the income test).
It is important for insurance claimants to be aware of any impacts to their Centrelink benefits before making any decisions on what to do with their super and insurance.
Andrew Reynolds is an ALA member
and a Certified Financial Planner.