Tech Update September 2005

Transcription

1 A Tech Update September 2005 Understanding insurance and Including insurance within can be of benefit to many clients, however there are also complex issues which need to be considered. This Tech Update, we explore the complex issues associated with holding insurance through. Advantages of insurance benefits in Including life and disability insurance in can be attractive because: Insurance premiums are generally not tax deductible if they are held outside a fund. Eligible persons can claim a tax deduction for contributions made into.the contributions can cover the cost of the insurance. Employees can minimise income tax by salary sacrificing an amount to which includes insurance. Effectively, contributions tax is not payable on the contributions used to fund the insurance premium, as the fund can claim a tax deduction for the cost of the insurance. Death benefits paid to a tax dependant are received tax free up to the deceased pension Reasonable Benefit Limit (RBL). Considerations of holding insurance benefits in When considering insurance in, three important factors are: Taxation of benefits Reasonable benefit limits (RBLs). Part 1 Life insurance in The tax treatment of a death benefit from needs to be considered, particularly where the member s Account balance and insurance benefits in exceed their pension RBL. In addition to this, the tax consequences if the member does not have any tax dependants should also be considered. Tax free up to Pension RBL Where death benefits from are paid to a tax dependant, they are received by the beneficiary tax free up to the deceased person s Pension RBL. Any amount received over the deceased person s Pension RBL is taxed as an excessive benefit. Payment to non dependants Although a person may be a dependant within the Superannuation Industry (Supervision) Act, it s possible they may not be considered a dependant under the Tax Act.The differences are summarised below in Table 1. A death benefit paid to a non tax dependant is not received tax free, regardless of the death benefit ETP amount. Table 2, over the page, summarises the tax treatment of death benefit ETPs. Table 1. Dependants Dependant includes: SIS Tax Spouse (including de facto) Yes Yes Previous spouse No* Yes Children (including adopted, ex nuptial, step) under 18 Yes Yes Children (including adopted, ex nuptial, step) over 18 Yes No* Any financially dependant person Yes Yes Interdependency relationship Yes Yes * unless the person is financially dependant

2 Table 2. Taxation of Death Benefit Eligible Termination Payment s (ETPs) Amount of benefit Benefit paid to Tax treatment Within the deceased s pension RBL Dependant Nil Non dependant Pre July 83 5% included in assessable income and taxed at beneficiaries MTR Post June 83 (taxed) 15%* Post June 83 (untaxed) 30%* No Post low rate threshold Above the deceased s pension RBL Dependant or Non dependant Post June 83 (taxed) -38* Post June 1983 (untaxed) - 47%* *plus Medicare levy Post June 1983 untaxed component When an ETP results from the death of a member, the Post June 1983 component may be classified as a taxed or untaxed element. Where the Trustee of the fund has not claimed a tax deduction for the cost of life insurance, the benefit is paid as a Post June 1983 taxed component. However, where the Trustee of the fund has claimed a tax deduction for the cost of the insurance, the taxed element will be calculated in accordance with the following formula: ETP x Where: Days in eligible service period Days in total service period ETP is the amount of the ETP reduced by the amount of the excessive component Days in eligible service period is the number of whole days in the eligible service period in relation to the ETP Days in total service period means the sum of: the number of whole days in the eligible service period in relation to the ETP and the number of whole days in the period commencing on the date of the death of the member of the fund and ending on the last retirement date. The remainder of the ETP will be the Post June 1983 untaxed component.this becomes more complicated where there is Pre service and undeducted contributions. Case Study Sandra, aged 50, died on 1 July 2005 with a balance of $400,000 plus life insurance proceeds of $100,000 in her self managed fund. Her eligible service date is 1 January Sandra s components before passing away were: Undeducted contributions $75,000 Pre 1 July 1983 component $111,418 Post 30 June 1983 component $213,582 The various components of her death benefit are calculated as follows: Step 1 Calculate the Undeducted Contributions (UDCs) Undeducted contributions = $75,000 Step 2 Calculate the Pre 1 July Component ETP x Pre days Total days $500,000 x 3,103 = $139,273 11,140 Step 3 Calculate the Post June 1983 Component ETP UDCs - Pre $500,000 - $75,000 - $139,273 = $285,727 Step 4 Calculate the Post June 1983 Component taxed Element The taxed element of the Post 30 June 1983 is calculated as explained in the formula above.

3 ETP x Total days Total days + days until age 65 $500,000 x 11,140 (11, ) $500,000 x 11,140 = $335,159 16,619 Step 5 - Recalculate the Pre 1 July 1983 Component This is based on a reduced ETP as calculated above. Reduced ETP x Pre days Total days $335,159 x 3,103 = $93,357 11,140 The Post June 1983 component using the reduced ETP amount is calculated using the standard ETP formula: Post 30 June 1983 component taxed element = reduced ETP all other components $335,159 - $75,000 - $93,357 = $166,802 Step 6 Calculate the Post 30 June 1983 Component untaxed Element This is calculated as: Post 30 June 1983 component (step 3) Post 30 June 1983 taxed component (step 4) $285,727 - $166,802 = $118,925 The components of Sandra s death benefits are: Undeducted contributions $75,000 Pre 1 July 1983 $139,273 Post 30 June 1983 taxed element $166,802 Post 30 June 1983 untaxed element $118,925 Total $500,000 Sandra nominated her adult son Paul as a beneficiary. He is 20 and not financially dependant on her. As his marginal rate of tax is 30%, $67, of tax is payable on the death benefit (assuming he pays a Medicare levy of 1.5%). Note:The Post June 1983 untaxed component is more than the life insurance. Including just $1.00 of life insurance in a fund, can mean that a Post June 1983 untaxed element is included in the ETP. The costs of including life insurance in should not outweigh the benefits. It is important to consider the amount of the life insurance and the taxation treatment of the benefit. Terminal Illness Benefit Terminal illness cover is generally provided by life insurance companies as part of a term life policy. Accordingly, where life insurance is taken out under, terminal illness cover may also be available. Qualifying for a terminal illness benefit does not necessarily allow the Trustee of the fund to make the payment. The Trustee of the fund can only pay a terminal illness benefit if the individual meets a condition of release. Depending on the client s age and circumstances, they will usually need to be permanently incapacitated.this can be a problem where a person is terminally ill but continues to work. In most cases, they will not be able to receive their terminal illness benefit. Taxation of benefit A terminal illness benefit is not paid as a death benefit ETP. It is taxed as a normal eligible termination payment.therefore, the tax payable will depend on the ETP components.the individual may qualify for an invalidity componentwhich will be paid tax free.this is covered further in Part 2. Part 2 Total and Permanent Disability (TPD) cover in Where TPD insurance is provided under, the preservation rules and taxation treatment of the payment need to be considered. If an individual wishes to make a claim under TPD provided by a fund, and access the insurance, it is necessary for them to satisfy a condition of release.the most obvious being the Permanent Incapacity condition of release (assuming they have not reached preservation age or met another condition of release).

4 Taxation of Total and Permanent Disability payment Generally, tax is payable on the TPD insurance payment, if paid from a fund.the amount of the tax will depend on: - the ETP components of the payment; - the age of the client; and - whether the client qualifies for an invalidity component. Except in limited circumstances, there would be no tax payable on a TPD benefit if held outside. Post June 1994 invalidity component Three conditions must be satisfied before an ETP can include a Post June 1994 invalidity component: 1. An ETP is made in relation to an employee in consequence of termination of employment; 2. The termination of employment is before the date the employee would have normally retired because of age or period of service; AND 3. Two legally qualified practitioners must certify that the employee s disability is likely to prevent the employee from ever being employed in a capacity for which they are qualified by their education, training or experience. Calculation of the invalidity component The invalidity component of an ETP is calculated using the following formula: Invalidity Component = Where: A = B = C = A x B C the amount of the eligible termination payment. the number of the days from the date on which termination occurred, to the last retirement date (being the date on which the person would have expected to retire, generally 65 years of age). the number of days in the actual eligible service period plus the number of days in B. Trap for self-employed individuals The current definition does not allow a self-employed person to be eligible for a Post-June 1994 invalidity component. As there is no termination of an employment arrangement, a self-employed person is ineligible for an invalidity component. An alternative option for self employed persons is to fund TPD insurance outside of. However, they will lose the tax deductibility of contributions to fund the insurance premiums. Case Study Natalie, aged 53, terminated employment on 1 August 2005 due to invalidity (Date of birth - 1 January 1952). She has decided to take an eligible termination payment from her fund of $500,000. Natalie s eligible service period commenced on 1 January 1975 and her last retirement date is age 65. ETP Components Amount Tax rate Pre July 1983 $101,127 5% included in assessable income Post June 1983 Taxed $262, % (including Medicare levy) Invalidity $135,934 Tax free The effect of the lump sum withdrawal is as follows: Assuming Natalie s marginal rate of tax is 30%, the total tax payable is $58,125 (assuming she pays Medicare levy). Strategy Natalie decides that she only wants to withdraw the invalidity component of $135,934 so that she doesn t pay any tax. She applies to the fund to withdraw $135,934. The Trustee calculates the invalidity component on the ETP amount of $135,934 on its own. Using the invalidity formula, the invalidity component equals $36,956.The remainder of the ETP is Pre July 1983 and Post June 1983 component. To allow Natalie to withdraw the full amount of invalidity component, she could potentially roll this amount over instead and create an ETP with an invalidity component, and then withdraw only that component.this would allow her to delay withdrawing her Pre and Post components until she reaches age 55.

5 Income protection In addition to providing benefits for members upon retirement,trustees can pay benefits in certain other situations. It is possible for Trustees to make benefit payments to members who are temporarily unable to work due to ill health. These benefits can be provided using insurance policies known as 'salary continuance' or 'income replacement' policies. The temporary incapacity condition of release allows a member to access benefits from their fund, where the Trustee is satisfied that the member has temporarily ceased work as a result of a physical or mental ill-health which does not constitute permanent incapacity. Taxation The limitations on tax deductibility for premiums relating to benefit periods that are greater than two years means that most salary continuance policies held through the person's are limited to a two year benefit period. The payments are not RBL assessed, and are not eligible termination payments.the payments are included as assessable income and taxed at the member s marginal rate of tax. Trauma insurance and Trauma insurance provides a benefit where the insured person suffers a crisis or trauma. A crisis or trauma generally means major, life threatening, medical problems such as cancer, heart attacks, and strokes. The SIS regulations do not specifically disallow funds from providing trauma insurance. However, providing trauma insurance under does raise questions about meeting the sole purpose test. It also raises an issue of when the benefit can be paid. A major consideration with trauma insurance is the problem of being able to pay the benefit to the member. If the trauma does not cause termination of employment and the member does not meet another condition of release, the fund will not be able to make the payment to the member. It is common for a person to suffer a trauma that does not mean they are permanently incapacitated. Where this happens, the Trustee will not be able to make the payment to the member, in almost all cases. Taxation The taxation treatment of the payment will be the same as a TPD payment. It will be taxed as a normal ETP.The member s ETP may qualify for an invalidity component, as explained previously, although this is less likely than if the member was receiving a TPD benefit. Summary Insurance, its treatment and how to hold it, is an important part of providing sound financial advice to your clients. Whilst there is a lot of focus on the taxation treatment of premiums and proceeds when received, the starting point is always to ensure that you have recommended a level of insurance cover appropriate to your clients circumstances. If you have any questions regarding the holding of insurance policies, or other issues raised in this Tech update, contact Technical Services by phone on or by at tech_services@sealcorp.com.au. Fr#dom IMPORTANT INFORMATION It is not the intention of ASGARD Capital Management Ltd ABN ,Australian Financial Services Licence Number (ASGARD) that this publication be used as the primary source of readers information but as an adjunct to their own resources and training. No representation is given, warranty made or responsibility taken as to the accuracy, timeliness or completeness of any information or recommendation contained in this publication and ASGARD and its associated companies will not be liable to the reader in contract or tort (including for negligence) or otherwise for any loss or damage arising as a result of the reader relying on any such information or recommendation (except in so far as any statutory liability cannot be excluded).the information ( advice ) in this publication does not take into account any person s personal objectives, financial situation or needs and, because of that, a person should, before acting on the advice, consider the appropriateness of the advice having regard to these factors. In deciding whether to open, or to continue to hold, an ASGARD Account, you should consider the relevant disclosure document or Product Disclosure Statement for that Account issued by ASGARD. Copies can be obtained from ASGARD or a financial adviser. ASGARD Capital Management Ltd ABN Australian Financial Services Licence Number Investor Services Sydney Level George Street Sydney NSW 2000 Telephone Facsimile Melbourne Level 41, ANZ Tower 55 Collins Street Melbourne VIC 3000 Telephone Facsimile Brisbane Level 21, Central Plaza One 345 Queen Street Brisbane QLD 4000 Telephone Facsimile Perth Level 38, Central Park 152 St George s Terrace Perth WA 6000 Telephone Facsimile Adelaide Level 25, Santos House 91 King William Street Adelaide SA 5000 Telephone Facsimile ANGTEU350905