By Monica Rule

When an SMSF member is diagnosed with a terminal illness, often the first thing they think of is how their family is going to survive without them.  Their superannuation savings is often the second largest asset they will leave behind for their loved ones.  So, understanding the options available in accessing their superannuation savings and obtaining their superannuation benefits, in the most tax effective way, can save money, time and stress for the member and their loved ones.

SMSF members faced with a terminal illness, who want to access their superannuation, have five options available to them. They will need to check if these benefits are payable from their SMSF by reviewing their SMSF’s trust deed:

1. Severe financial hardship grounds

   There are two different conditions of release to access superannuation savings under this ground which are based on the age of the SMSF member. 

   1. If the member has not reached their preservation age, then the SMSF trustee must be satisfied, based on written evidence, that the member is unable to meet reasonable and immediate family living expenses and has received a Commonwealth income support payment for at least the previous twenty six weeks.  The amount that can be accessed is restricted to one payment of no more than $10,000 in each twelve month period.   

   2. If the SMSF member has reached their preservation age, then the member will need to satisfy the SMSF trustee that they are unable to meet reasonable and immediate family living expenses and that they have been in receipt of a Commonwealth income support payment for a cumulative period of at least thirty nine weeks after reaching their preservation age and they are not gainfully employed on the date of the application.  There is no payment restriction. 

   Commonwealth income support payment means – a social security benefit or an income support supplement. 

2. Compassionate grounds

   The SMSF member can access their superannuation savings under this ground to pay for things such as:  medical treatment, where the treatment is not readily accessible through the public health system; to make a loan or mortgage payment to prevent a foreclosure; to pay for expenses associated with a funeral; or, to modify the family home to meet special needs.  The application to access superannuation savings under this ground must be made to the Department of Human Services.

   If the SMSF member qualifies and is able to access their superannuation savings under financial hardship grounds or compassionate grounds, then the superannuation benefit will be paid as a lump sum.   The benefit cannot be paid as a pension. The lump sum benefit is tax free if the member is aged sixty or over.  If the member is below their preservation age, then tax is payable at a maximum of twenty per cent on the taxable component of the benefit.  If the member has reached their preservation age, then the amount of the taxable component up to the “low rate cap” (for 2016/2017 it is $195,000) is tax free, and the balance is taxed at a maximum of fifteen per cent. 

3. Terminal medical condition grounds

   The SMSF member can access their superannuation savings under this ground if they have a terminal medical condition and two medical professionals (where one is a specialist in the area related to the illness) certify that the condition is likely to result in the member’s death in the next twenty-four months.

   If the member qualifies, then they can elect to receive the terminal illness benefit as a lump sum payment or as a pension. The tax treatment for a lump sum benefit is that it is paid tax free regardless of the member’s age and the components of the lump sum benefit. 

   If the member decides to receive the benefit as a pension, then tax is payable at the member’s marginal tax rate on the taxable component of the pension if the member is below their preservation age.  If the member has reached their preservation age, then tax is payable at the member’s marginal tax rate on the taxable component with a fifteen per cent tax offset available.  If the member is aged sixty or above, the pension is tax free. 

4. Permanent incapacity grounds

   The SMSF member can access their superannuation savings if they have ceased gainful employment and are unlikely, because of physical or mental ill-health, to ever again engage in gainful employment for which they are reasonably qualified by education, training or experience.

   The difference between accessing superannuation under “terminal medical condition” and “permanent incapacity” grounds is that under the terminal medical condition, the SMSF member can continue to work while or after accessing their benefit; whereas, under the permanent incapacity ground, the member cannot continue to work while or after accessing their superannuation benefit. 

   To access superannuation under permanent incapacity grounds, the SMSF member will need to satisfy the SMSF trustee that they are unlikely to engage in gainful employment in a capacity for which they are reasonably qualified by education, training or experience.

   The SMSF member can elect to receive the permanent disability benefit either as a lump sum or a pension. 

   If the member decides to take the disability benefit as a lump sum, it is not entirely tax free unless the member is age sixty or above.  If the member is below their preservation age, then tax is payable at maximum of twenty per cent on the taxable component of the lump sum.  If the member has reached their preservation age, then the amount of the taxable component up to the “low rate cap” (for 2016/2017 it is $195,000) is tax free, and the balance is taxed at a maximum of fifteen per cent.

   However, an SMSF member can qualify for an increased tax free lump sum amount if two legally qualified medical practitioners have certified that the member is unlikely to ever be gainfully employed in a capacity for which they are reasonably qualified because of education, experience or training.  The increased tax free amount is calculated as follow:

   Amount of benefit	x	Days to retirement (date they stopped working to their 65th birthday)
   		Service days + Days to retirement (date they commenced with the SMSF to their 65th birthday)

   If the SMSF member decides to take their disability benefit as a pension and they are under the age of sixty, then the tax payable on the pension is at their marginal tax rate on the taxable component with a fifteen per cent tax offset available.  If the member is aged sixty or above, the pension is tax free.

   Gold and Platinum Members, Monica has provided an example of how to calculate the increased tax free amount of a lump sum disability benefit.

   

5. Death Benefit

   Upon the SMSF member’s death, the SMSF trustee is required to pay out the deceased member’s superannuation savings to either their dependant(s) or their legal personal representative as soon as practicable.

   The tax treatment of a death benefit is based on whether the recipient of the death benefit is classified as a “death benefit dependant” under the Income Tax law. 

   If the recipient is classified as a “death benefit dependant”, then they can receive the deceased member’s superannuation tax free if it is paid as a lump sum death benefit.

   If the death benefit recipient does not qualify as a “death benefit dependant”,  then tax is payable on the taxed element of the taxable component of the lump sum at a maximum of fifteen per cent and on the untaxed element at a maximum of thirty per cent.  A lump sum death benefit paid to a non-dependent will only include an untaxed element if the SMSF has claimed a tax deduction for a life insurance policy taken out on the deceased member.  If no tax deduction has been claimed, then the proceeds of the insurance policy will be treated as a taxed element of the taxable component.  

   If the death benefit is paid as a pension and neither the deceased member nor the recipient is aged sixty or over, then tax is payable on the taxed element of the taxable component at the recipient’s marginal tax rate with a fifteen per cent tax offset. The untaxed element of the taxable component is taxed at the recipient’s marginal tax rate with no tax offset available. 

   If either the deceased member or the recipient is aged sixty or over, then the taxable component of the death benefit pension is tax free.  However, the untaxed component of the pension is taxed at the recipient’s marginal tax rate with a ten per cent tax offset. 

   A death benefit pension will only have an untaxed element if the pension is paid from a superannuation fund that has not paid any tax on the contributions or earnings (e.g. Public Sector Super Schemes and Constitutionally Protected Funds).

   Gold and Platinum Members, Monica has provided an explanation of how to calculate an “untaxed” element of a lump sum death benefit payable to a non-dependent.

   

Monica Rule is an SMSF Specialist and author of “The Self Managed Super Handbook – Superannuation Law for SMSFs in plain English” www.monicarule.com.au

Disclaimer: The content of this Bulletin is general information only. It is not legal advice. The statements and opinions are the expression of the author, not Law Central, and have not been checked for their accuracy, completeness or changes in the law. Law Central recommends you seek professional advice before taking any action based on the content of this Bulletin.

Related documents:

• SMSF - Deed Update
• Pension Pack for Self Managed Super
• Will - Married or Defacto No Children
• Will - Married or Defacto with Children
• Will - Single No Children
• Will - Single With Children

Related webinars:

• Webinar Recording - Pitfalls that SMSF Trustees should avoid
• Webinar Recording - Avoiding Business Disputes
• Webinar Recording - Tips and Traps for Property Investment in your SMSF