A guide to SMSF tax deductions and insurance

Some self-managed super funds can claim tax deductions for the future liability to pay death and disability benefits. Nicholas Ali explains.

As an alternative to claiming a tax deduction for death or disability insurance premiums, a fund can claim a deduction for the future liability to pay death and disability benefits in the year of the payment.

If the trustee pays a death or disability benefit during the financial year, they can choose not to claim a deduction for the premiums paid, but instead elect to claim a deduction based on the future service of the benefit paid.

The tax deduction is available under section (s)295-470 of the Income Tax Assessment Act 1997. Any election to claim the deduction is made under s295-465(4).

The choice applies if one of the following benefits is paid:

• Lump sum death benefit;
• Terminal illness benefit;
• Disability superannuation benefit;
• Temporary incapacity benefit.

This option applies only to members under 65 – if the member receiving the benefit is over 65, no tax deduction is available to the fund.

If the trustee chooses to claim a deduction for paying the benefit, a deduction is not available for any insurance premiums paid in the year the benefit is paid, or any future year (sec 295-465(5)). This restriction applies to premiums paid for all members.

The benefit of claiming the tax deduction for the future liability is that the amount of the deduction at the time of the relevant benefit payment may be greater than the deduction available for any future insurance premiums.

This deduction will only be valuable if any remaining members are in accumulation. If a pension member is the only remaining member, the deduction is first offset against the exempt income of the pension assets so any tax savings effect is gradually lost.

Any loss created by the future liability deduction can be carried forward to future years. This may benefit other members of the fund in accumulation, as it can be used to offset assessable contributions and fund earnings.

The available deduction is calculated on the entire benefit amount paid, which includes the insurance proceeds.

The amount of the future liability to pay benefits is calculated using the formula:

Benefit amount x (Future service days/Total service days)

Benefit amount is either of the following, depending on how the benefit is paid:

• Lump sum – amount of lump sum;
• Income stream – value of interest supporting the stream;
• Temporary disability benefit – the total of the amounts paid during the year.

‘Future service days’ is the number of days in the period starting when:

• The employment termination occurred due to death;
• The member became unable to engage in gainful employment and ending on the member’s last retirement date (usually age 65).

‘Total service days’ is the sum of future service plus the member’s eligible period days.

Case Study

David, 50, is married to Celeste and has been a member of his fund since 30 June 1991. His balance in the fund at the time of his death on 30 June 2011 is $500,000.

The fund also owns a life insurance policy for $1,000,000, with an annual premium of $2,000.

Celeste is to receive a death benefit lump sum which will be paid in the 2011/2012 financial year – which is the year that the fund will be entitled to claim the future liability tax deduction.

Benefit amount: 
$1,500,000 

Future service days: 
5,480

Total service days:
12,785

The future liability tax deduction:
$1,500,000 x (5,480/12,785)

Total: 
$642,940 Deduction

If the fund has assessable income of $67,500 in the 2011/1012 financial year, it is entitled to offset income in the 2011/12 financial year with this tax deduction and carry forward the remainder to offset against future income of the fund.

Therefore, the deduction of $642,940 is reduced by the assessable income of $67,500, meaning the fund pays no tax in the 2011/12 financial year and $575,440 (ie, carry forward deduction of $642,940 less assessable income of $67,500) is carried forward as a deduction to offset assessable income in future years.

To be eligible to do this, the fund cannot claim the insurance premiums in the 2011/12 financial year, or in future years for all members in the fund.

While the tax deduction for the future liability to pay death and disability benefits can provide distinct benefits for SMSFs, the strategy is a specialised one and clients and their financial advisers should seek advice from a suitably qualified SMSF professional.

Nicholas Ali is the technical services specialist at Super Concepts.