Planning for the terminally ill client

The three most important questions an adviser needs to ask in this situation are:

1. Does the client need to access his/her superannuation savings to see them through?

2. Does the client have life insurance within the superannuation system and, if so, will they exceed their Reasonable Benefit Limit (RBL) once death benefits are added to existing superannuation savings?

3. Are the client’s affairs in order from an estate planning point of view?

If the client is aged 55 or over, getting money released from the superannuation system can be a routine process where the client is intending to leave the workforce permanently. But if they’re under retirement age, the trustee needs to be contacted to find out whether they’ll allow funds to be ‘cashed out’ and under what conditions.

Generally speaking, clients under 55 will need to satisfy the superannuation definition of ‘permanent incapacity’ for the savings to be released. And for that to happen, the trustee needs to be reasonably satisfied that the member is unlikely to be gainfully employed ever again because of ill health (physical or mental).

The first step an adviser needs to take in the planning process is to examine the client’s complete superannuation picture. That means working out their RBL situation, including any death benefits. A common mistake is to leave insurance payouts out of the equation, which could adversely affect the tax treatment to beneficiaries.

Other things to check:

n Does death cover allow for accessing a terminal illness payment prior to death?

n Does the fund allow binding nominations to be made? If not, would the client be better off from an estate planning point of view to roll over their savings into a fund that does? Binding nominations cannot be disputed (provided they are made to dependants or an estate) and allow for the creation of an income stream for children that doesn’t incur minors’ tax (much like a testamentary trust, minus the often hefty set-up fees.)

n Does the client’s superannuation fund offer a refund on contribution tax upon payment of death benefit to dependants? If not, would the client be better off rolling their savings into another fund that does? (A refund is usually only available if the recipient is classed as a dependant.)

Before suggesting that a client rolls over their savings into another fund for tax or estate planning reasons, make sure this doesn’t adversely impact on any existing life cover.

With public offer funds, the client should be able to continue their risk cover through their existing fund even if they transfer the bulk of their savings elsewhere or alternatively cash them out. Some employer funds will also allow you to do this. Be sure to leave an adequate balance within the fund for this purpose, allowing a safe margin in case the client outlives his/her doctors’ expectations.

If you have a client who will incur an excessive RBL component — either through their estate or as a result of cashing their savings out now — check out whether they can qualify for a post June 30, 1994, invalidity component. Invalidity components do not count towards a taxpayer’s RBL and, subject to satisfying a condition of release, can be withdrawn from the superannuation system tax-free if required.

This little understood tax provision only applies to employees (not self-employed or unemployed people) who have their employment terminated as a result of their ill health.

For your client to qualify, two legally qualified medical practitioners have to certify that the disability is likely to mean that the taxpayer will never be able to work again in the capacity for which they are reasonably qualified through their education, training or experience. (These medical certificates could also be re-used by a person under retirement age to gain release of superannuation monies from a fund under the permanent incapacity condition of release. Be sure to check first with the trustee to ensure they include all the requisite details.)

To calculate the size of the client’s invalidity component (Section 27G of the 1936 Tax Act), simply multiply the client’s superannuation Eligible Termination Payment (ETP) by the time from termination to retirement age (generally 65) and divide that by the total service period up to retirement age.

For example, if your client is aged 50 (15 years from retirement), has an $800,000 ETP and an eligible service period of 15 years, then their invalidity component would be calculated as follows:

$800,000 (ETP) x 15 (years from termination until retirement) = $400,000

30 (total service years if taxpayer had worked until retirement)

This client could effectively cash out his entire savings without incurring an excessive component, as only $400,000 of the ETP would be counted towards his/her available lump sum RBL.

Bear in mind that normal ETP tax will apply to the non-validity component of the payout. Likewise, if a client is younger than 55, the lump sum RBL is discounted by 2.5 per cent for every relevant year.

This application could equally benefit a client who plans to leave their superannuation savings to dependants, but would otherwise exceed his/her available pension RBL.

Another important thing to be aware of is that the invalidity component can be claimed on more than one fund.

Having established the availability of the invalidity component, the client has to crystallise it before they die. An ETP must be created to do this, either by cashing out the funds or rolling them over into another super fund. Again, care needs to be taken to ensure this option doesn’t terminate or adversely affect a client’s insurance coverage.

Jeff Levins is risk specialist with Zurich FinancialServices Australia