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Taxation of super benefits

Taxation of disability super benefits

Section: 7.8

A disability super benefit is a super benefit where:

  • the benefit is paid to a person because he or she suffers from ill health  (whether physical or mental), and
  • two legally qualified medical practitioners have certified that, because of the ill health, it is unlikely that the person can ever be gainfully employed in a capacity for which he or she is reasonably qualified because of education, experience or training.

A disability super benefit may be paid as a lump sum or an income stream. A member must meet the permanent incapacity condition of release in the SIS Regulations to receive a disability super benefit. If the disability super benefit potentially includes an insurance payout, the member must also meet the insurer's definition of total and permanent disablement.

The ATO released Superannuation Client Relationship Team Alert 020/2015 that provides direction for the calculation of the increased tax free amount for a super lump disability benefit.

Currently, there is a variation in the formula's  denominator where some providers double count the days that occur in both the 'service days' and days to retirement' and others do not.

The ATO has concluded in the formula's denominator, any days that are included in the both 'service days' and 'days to retirement' are to be only counted once. Therefore,  the denominator is equal to the number in days in the period from the start date of the super interest to the person's 'last retirement date'.

Implications for clients:

  • Not double counting these days in the denominator yields a higher increased tax free component. Check that the super provider is not double counting these days in the denominator prior to receiving a super lump sum disability benefit.
  • Ensure that your SMSF clients are aware of this ATO direction

Disability super benefits are taxed as super lump sums (see section 7.1) or super income streams (see section 7.11) as appropriate, with two modifications detailed below.

15% tax offset
Where a person under age 60 receives a disability super benefit paid as a super income stream, he or she is entitled to a 15% tax offset on the taxed element of the taxable component. Untaxed elements of taxable components do not receive the 15% tax offset.

An untaxed element may occur where a disability super benefit is paid from an untaxed or unfunded super scheme.

Modification for disability benefits
If a person receives a lump sum disability super benefit, the tax-free component of the benefit is increased for the future service benefit - broadly reflecting the period where they would have expected to have been gainfully employed. Historically, this extra tax-free benefit was only available to employees.

Calculating the tax-free component of a disability lump sum:
  • the sum of the tax-free component of the benefit worked out apart from using the disability formula, plus
  • the amount worked out under the disability formula below (note: the tax-free component cannot exceed the amount of the benefit).
                                                                                 days to retirement
Amount of lump sum benefit  X  ( ---------------------------------------------------------- )
                                                                service days + days to retirement

where:

  • days to retirement is the number of days from the day on which the person stopped being capable of being gainfully employed to his or her last retirement day (generally age 65), and
  • service days is the number of days from the day the member joined the fund or, if a rollover amount was received by the fund with an earlier service period start date, that earlier start date to the date of death. For an employer sponsored fund, service days may commence when the member's employment commenced, if that was prior to the commencement of their fund membership

The balance of the super benefit is the taxable component of the benefit.

Note: When calculating the modified tax free component using this formula the ATO has confirmed that any days that are included in both 'service days' and 'days to retirement' in the denominator are to be counted only once. Therefore, the denominator will always be equal to the number of days in the period from the start of the 'service period' for the disability lump sum to the person's 'last retirement day'. This ensures the proportion of tax free component included in a member's disability superannuation benefit payment will not change where a member either delays taking a benefit payment or takes their benefits as multiple smaller payments over an extended period of time.

Commencement of an account-based pension
The commencement of an account-based pension with the same super trustee does not constitute a payment which allows the trustee to increase the tax-free component for someone who is permanently incapacitated. As a result, the tax-free and taxable component of the account-based pension at commencement will have the same components as the super interest which supports the pension. For more information refer to ATO ID 2009/125.

In contrast, a disability super benefit that is rolled to a new fund to commence an account based pension will qualify for the increased tax-free component.

Last modified: Tuesday, May 2, 2017