$600k SMSF Tax Deduction

21 Apr 2021

Written by

David Busoli, Principal

Sadly, one of our 45 year old SMSF members has received a terminal illness benefit payout of $1m into his fund. This has increased his balance to $1.3M and provided the fund with the ability to create a $600k income tax deduction. As is often the case, there is more to this than meets the eye.

I have previously mentioned the future service deduction as a significant benefit available exclusively to SMSF members. This particular situation is unusual in that the member is not deceased or totally and permanently disabled, he has been diagnosed with a terminal illness. This introduces further issues.

The future service deduction requires the event to cause a cessation of employment. A terminal illness diagnosis recipient will often feel well enough to continue working but cessation is necessary to receive the tax benefit.

The major beneficiary of the tax benefit will generally be other members of the fund. In this case his adult independent children, as they will not pay contribution tax or tax on their accumulation accounts for some time. The potential saving is as much as 15% of $600k = $90k. In another scenario it could be a surviving spouse with an accumulation account who will benefit.

The payout may be a lump sum, pension or combination. In many cases the member will choose to commence a pension. This creates its own issues as a pension account will reduce the tax deduction over time. This is because income tax losses in the fund are reduced by its taxable profit prior to the pension tax exempt provision being applied.

Generally, this can be dealt with by simply rolling over the pension account to another fund. This becomes problematic when the trigger has been terminal illness as the rules are different.

For a terminal illness scenario, a rollover is processed as a tax-free withdrawal and personal contribution to the second fund. As a non-concessional contribution is limited by the caps and previous year’s total super balance this will generally prove difficult.

Just to ensure that these considerations are not too easy there are also a couple of side issues.

  • assuming that the terminal illness certification was for the maximum 2 years, the pension will cease after that time unless the condition is recertified.
  • If the ultimate benefit is to be paid to adult independent children on the member’s death, there will be additional lump sum tax payable due to the presence of an untaxed element unless the benefit is withdrawn by the member prior to death.

What’s the best way forward? It depends!!!

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