TPD payouts and tax implications dependent on member’s age: expert

Peter Johnson, director of Advisers Digest, said when an SMSF member is over 60 years old, all benefits they receive are tax-free.

“If you receive a TPD when you’re young, you get your benefit tax-free. If you get it when you’re older it has a taxable component, but once you’re 60, that comes out tax-free. If you’re 40-45 years, and it’s 50/50, it just means the benefit you get, part of it will be taxable,” he said.

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“So, if you receive a TPD the day before you turn 65 it is going to make all of your benefits a taxable component, but if you get your TPD on the day you turn 65, the start of your eligible service period, then it will all be a tax-free component.”

Johnson gave an example of an SMSF client whose fund holds a TPD policy with premiums paid by the fund and allowable deductions claimed over several years.

The TPD of $870,000 was recently paid out and received into the fund’s bank account. The member is currently 60 years of age and his account has been in full pension phase. As at the date of the last completed SMSF accounts the member’s wife, the only other member, had no balances.

This therefore means the SMSF is largely in a tax-free state on investment earnings.

“The question therefore revolves around tax, if any, on the TPD policy proceeds, given the SMSF is in a 100 per cent pension state and earnings are tax-free,” he said.

Johnson said once a TPD payment is made, it’s important to look at the formulas contained within the Income Tax Assessment Act to work out how much is of a taxable component.

“With a death benefit, you want to die older. With a TPD benefit you want to be younger. You don’t want to die young with a death benefit. A lot of that will be untaxed,” he said.

“If the TPD goes to a death benefits dependent, you’re fine. If it goes to you, you’re fine. It’s when it goes to an adult beneficiary that you must look at how much money is coming out.”

If the member is under 60, Johnson said the TPD can be taken out as a lump sum with a component that will be tax-free and a 15 per cent tax imposed on the remainder.

“If the TPD is taken out as a pension, it is taxable, but you do get a rebate. All those things come into play when the member receiving the TPD is over 60 and the money goes into the fund,” he said.

“It’s also important to remember that if it goes into a pension it goes into an accumulation balance, and the member would then have to recommence a pension if they wanted, or to take it out as a lump sum.”

Johnson added it is best to review the ITAA if claiming a tax deduction for insurance benefits such as TPD.

“The fund is the owner of the policy. The member is insured. The member suffers an event where they are now totally and permanently disabled. The insurer has accepted their TPD and paid a lump sum to the fund. We know that it is CGT exempt in the CGT provisions of the act, but it is the timing of when the money comes out that is important,” he said.

“If it’s coming out before you are 60, it is a lump sum benefit to the member.”