David Busoli, SMSF Alliance principal, said a lump sum disability payment is generally sourced from a combination of life insurance proceeds (received tax-free by the fund) and savings.
“Unless the member has made non-concessional contributions previously, the member’s benefit will comprise a 100 per cent taxable component. When a lump sum disability payment is made, a formula converts some, or all, of the taxable component to a tax-free component,” he said.
“The interesting thing is that the formula is applied if a payment is made from an accumulation account, a pension account or, most importantly, if the member rolls over their benefit to another superannuation fund.”
Busoli said this may present some opportunities to maximise the tax-free component, particularly if the member wishes to retain their member balance in the superannuation environment and start a pension.
“A pension commenced prior to the rollover will not have an increased tax-exempt component so the pension payable from the taxable component will be taxable with a 15 per cent tax offset if the beneficiary is under age 60.”
“If the member rolls over before starting the pension, the increased tax-free component ensures that part of the pension will be permanently tax-free. This provides the additional potential benefit of increasing the tax-exempt component which might, eventually, form part of a death benefit payout to a non-tax dependant.”
Furthermore, Busoli added that if a non-concessional contribution is added before taking a lump sum, or rolling benefits to another fund, the tax-exempt component grows even more.
“This is because the formula to determine the additional tax-free component references the member’s total account balance, inclusive of the tax-exempt amount.”
“It’s even possible that the calculated tax-exempt component could be greater than the member’s account balance, in which case it is 100 per cent tax-exempt.”
He gave an example of Jack who was born on 1 January 1980 and has an eligible service date of 1 January 2010.
Jack became totally and permanently disabled on 1 January 2025. At the time, his superannuation account had $1 million in combined savings and insurance proceeds which is all a taxable component.
“When Jack draws a lump sum benefit or rolls to another fund, his taxable component reduces to $428,583,” Busoli said.
“If Jack had made a $360,000 non-concessional contribution just prior, his taxable component would further reduce to $222,872.”
