Taxation of insurance payments through super Fact Sheet - October 2014 Insurances such as life, total and permanent disability (TPD) and income protection (IP) can be taken through super. The trustee of the super fund is the policy owner and can claim a tax deduction for the premiums. Note: Since 1 July 2014, only insurance that aligns with the conditions of release of death, terminal medical condition and permanent and temporary incapacity, can be offered in super. Proceeds of a death policy are paid tax-free to the trustee and added to the client s super benefit. The insurance benefit is paid as part of the total death benefit and will make up part of the taxable component but can include elements both taxed and untaxed. TPD insurance proceeds are paid tax-free to the trustee of the super fund and the lump sum payment is taxed at normal super lump sum tax rates. Note: An additional tax-free amount may be calculated where a disibility super benefit is paid. IP, also known as salary continuance, is paid tax-free to the fund and then paid to the client as a taxable income stream from super (taxed at marginal tax rates). This Fact Sheet discusses taxation of benefits from a taxed super fund (ie. funds that tax earnings and contributions) and does not cover untaxed public sector funds. Life cover Upon death, the balance of the client s account (including insurance proceeds) is generally paid to dependants and/or the estate. Tax-dependant If a super death benefit is paid as a lump sum to a tax-dependant, the entire benefit (including insurance proceeds) is tax-free. A death benefit pension can only be paid to certain dependants ie, spouse, certain children, interdependents or financial dependents. If paid to a child, they must be under age 18, aged 18<25 and financially dependent, or disabled. If a death benefit pension is paid and either the deceased or the beneficiary are aged 60 or older, all payments will be tax-free. If both are under age 60, the taxable portion (including insurance proceeds) of pension payments will be assessable, but a 15% tax offset will apply. If the deceased was age 60 or older, the income payments from a continuing pension will continue tax-free to the reversionary dependant beneficiary. Asteron Life 1
Non-tax dependant Payments to non-tax dependants can only be paid as a lump sum with the following tax rates: Component Tax rate Tax-free 0% Taxable Element taxed 15%* Element untaxed 30%* * Plus Medicare levy of 2% An element untaxed applies if the death benefit includes an insurance payment where either the premiums or future liability to pay a benefit have been claimed as a tax deduction by the super fund. This portion relates to the future service period (ie. the period of service from date of death up to retirement age, which is normally 65) of the total benefit. If the proceeds from a life policy will be paid to a non-tax dependant, consideration should be given to holding insurance outside super so it can be received tax-free. Case study Tom (age 50) has a wife, Sandra (age 49) who does not work and an adult child, Sam (age 26). His accumulated super totalled $100,000 and included a $42,200 tax-free component. He also had $400,000 life cover through his fund so the total death benefit is $500,000. Assume: Service days of 8,395 and days to retirement of 5,475 days. Option 1 - Sandra takes benefit as a lump sum (dependant) Sandra is a tax-dependant so she can receive the $500,000 as a tax-free lump sum. Option 2 - Sandra takes benefit as an income stream (dependant) Tom died before turning age 60, so the tax depends on Sandra s age. As she is under age 60, tax is payable at her marginal rate (less a 15% tax offset) on the taxable portion of income payments. Calculate tax-free/taxable split: Tax-free portion: $42,200/$500,000 = 8.44% Taxable portion: $457,800/$500,000 = 91.56% Sandra elects to draw a pension of $35,000. The taxable portion of $32,046 (91.56%) is included in her assessable income but receives a 15% tax offset. The remaining $2,954 is tax-free. Assuming Sandra has no other income or deductions: Gross pension $35,000 Less tax-free amount $2,954 Taxable income $32,046 Tax $2,631 Medicare levy $641 Less: 15% offset (15% x $32,046) $4,807 Tax payable $641 The 15% offset reduces Sandra s tax liability to $641, so she receives $34,359. Where death benefits (including insurance proceeds) are paid to tax-dependants as a lump sum (including via the estate) no tax is payable. Tax may be payable if death benefits are taken as an income stream, although this can be reduced or eliminated through tax offsets. Option 3 - Death benefit is paid to Tom (non tax-dependant) If Tom s benefit was paid to Sam (his adult child who is a non tax-dependant) it must be paid as a lump sum and tax is payable. Insurance is included in the benefit so an element untaxed is calculated. Asteron Life 2
Step 1 calculate the element taxed. This is a two-part process: (A) total benefit x service days* # days to retirement the number of days from death to last retirement day (usually age 65) * service days number of days from the start of the eligible service period to date of death service days + days to retirement # $500,000 x 8,395 = $302,632 (B) Step 2 remainder of the benefit is element untaxed 13,870 deduct the tax-free component from the amount calculated in (A) element taxed = $302,632 - $42,200 = $260,432 element untaxed = $500,000 - $42,200 - $260,432 = $197,368 Sam would pay tax of $105,142 on the $500,000 death benefit (see calculations in table below). Component Tax calculation Tax payable Tax-free component $42,200 x 0% nil Taxable component Element taxed $260,432 x 17%* $44,273 * Includes Medicare levy of 2% Element untaxed $197,368 x 32%* $63,158 An element untaxed attracts a higher rate of tax. The element untaxed does not need to be calculated if a benefit paid from a taxed fund only includes accumulated savings, ie, there is no insured benefit. TPD cover Taking TPD through super can create complications not experienced if cover is held outside super. If TPD cover is held inside super, the client must: 1. meet the TPD definition under the insurance contract (for the claim to be paid) 2. meet the TPD definition or another condition of release under super law (to access the money) 3. meet the disability super benefit definition under tax law (so an additional tax-free portion can be calculated on a lump sum benefit). There is no element untaxed in a disability payment unless paid from an untaxed source. Taxation of disability benefits Benefits can be received by the client as a lump sum or income stream. The following tax rules apply for disability payments from a superannuation fund: Client s age Lump sum Income stream payments Age 60+ Total benefit 0% Tax free Preservation age < age 60 Tax-free component 0% Taxed portion of income stream is included in Taxed component assessable income and taxed at marginal tax rates less a 15% tax offset. first $185,000^ 0%* balance 15%* Under preservation age Tax-free component 0% * Plus Medicare levy of 2% ^ Reviewed for indexation on 1 July each year Taxed component 20%* Taxed portion of income stream is included in assessable income and taxed at marginal tax rates less a 15% tax offset. Asteron Life 3
Calculating disability tax-free portion (lump sums only) The tax-free portion of a disability super lump sum is calculated as: Additional tax-free = total benefit x days to retirement service days + days to retirement This amount is added to the existing tax-free component in any accumulated savings. Example John is age 40 and has an accumulated super balance of $100,000. This includes a $25,000 tax-free component. He has insurance of $400,000 for death and TPD. John becomes permanently disabled and requests to receive his benefit as a lump sum. The insurer pays the proceeds to the super fund trustee. The trustee agrees that the relevant definitions under super law (to access the benefit) and tax law (to qualify as a disability super benefit) have been met. Assume days to retirement of 9,131 and service days of 7,531 days The extra tax-free component is calculated as follows: New tax-free component: Taxable component: Total benefit = $500,000 Days to retirement = 9,131 Service days + days to retirement = 16,662 $500,000 x (9,131/16,662) = $274,007 additional tax-free component $274,007 + $25,000 = $299,007 $500,000 $299,007 = $200,993 Tax component Amount Tax Tax-free $299,007 nil Taxable $200,993 $200,993 x 22% (including Medicare) = $44,218 Total $500,000 $44,218 A disability super benefit will arise if the person suffers physical or mental ill-health and two legally qualified medical practitioners certify that it is unlikely the person will ever be employed in a job in which they are qualified (based on education, training and experience). Income protection Income protection benefits are paid as an income stream. The total payment is taxable income and taxed at marginal tax rates regardless of the client s age. No special tax offsets apply. Employer group risk insurance It is common for employers to provide life, TPD and income protection insurance for their employees via a group policy on the lives of the employees. A group risk policy can be purchased inside or outside superannuation. Outside super Tax implications of payment of premiums Where the employer owns a life or TPD insurance policy and the employee is not contractually entitled to the proceeds, the premiums will be tax deductible to the employer and Fringe Benefits Tax (FBT) will not apply. If the employee is entitled to the proceeds, FBT may apply but may be deductible to the employer. FBT is not applicable to income protection premiums. Tax deductibility of premiums Life, TPD and income protection premiums are generally deductible to the employer. Asteron Life 4
Tax implications on receipt of insurance proceeds by the employer The proceeds of life, TPD and income protection insurance are assessable income of the employer. Life and TPD proceeds are then paid to the employee via an employment termination payment (ETP) and income protection proceeds as salary. The employer can claim a tax deduction on salary and ETPs. Tax on payment to employee Life and TPD insurance proceeds would be payable to the employee as an employment termination payment and taxed accordingly. Income protection proceeds are taxable income and taxed in the employee s hands at their marginal tax rate. Inside super Tax implications of payment of premiums Premium payments are made from super contributions or existing super balance. The premium payments are not a fringe benefit. Therefore, the premiums do not attract FBT. Tax deductibility of premiums Premium payments are tax deductible to the super fund trustee. Tax implications on receipt of insurance proceeds by the employer Insurance proceeds are paid tax free to the trustee and taxed as a super benefit to the member or beneficiary. The table below compares employer-owned insurance inside and outside super. Employer funded insurance Inside super Outside super Premiums paid by Trustee Employer Premiums deductible to Trustee Employer FBT payable on life and TPD premiums No Yes* FBT payable on income protection premiums No No^ Tax on life insurance proceeds to taxdependants Tax-free Up to $185,000** tax free Tax on life insurance proceeds to non-tax dependants Tax on TPD insurance proceeds Taxable (taxed element) 17% Taxable (untaxed element) 32% Age 60 or over tax free Under age 60: Taxed as normal super lump sum, however a disability super benefit may apply to increase the tax-free component. Up to $185,000** 32% Any invalidity or pre-1983 amount tax free Under preservation age: Up to $185,000** 32% Over preservation age: Up to $185,000** 17% * FBT applies if the employee has rights or entitlements to benefits under the contract ^ No FBT as premiums would be otherwise deductible to the employee **Current for the 2014/15 financial year Asteron Life 5
Contact Details Technical Services Suncorp Portfolio Services Limited ABN 61 063 427 958 AFS Licence No. 237905 For more information on Asteron product solutions, please contact the Sales Manager in your State. NSW/ACT Level 10 321 Kent Street Sydney NSW 2000 T 02 8275 3411 NSW callers outside Sydney: 1800 805 241 VIC/TAS Level 33 530 Collins Street Melbourne VIC 3000 T 03 9245 8500 VIC callers outside Melbourne: 1800 803 628 QLD Level 10 36 Wickham Terrace Brisbane QLD 4000 T 07 3011 8600 QLD callers outside Brisbane: 1800 177 716 SA/NT Level 18 45 Grenfell Street Adelaide SA 5000 T 08 8205 5333 SA callers outside Adelaide: 1800 506 274 WA Level 2 15-17 William Street Perth WA 6000 T 08 9260 7000 WA callers outside Perth: 1800 799 537 Important note The information contained in this publication is of a general nature only and is intended for use by financial advisers or other licensed professionals only. it must not be handed to clients for their keeping nor can any copies of sections of this publication be given to clients. The information has been compiled based on regulatory policy at the time of writing. We recommend that your client refer to their professional tax or legal adviser prior to implementing any recommendations you may make based on the information contained in the publication. 10/2014