Tax paid by your SMSF can be returned to your dependants

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How would you like the tax paid by your SMSF to be returned to your dependants upon your death? An anti-detriment payment can make it possible.

Why is a refund possible?

Prior to 30 June 1988, superannuation funds paid no tax on deductible contributions. Benefits payable (in respect of the membership period after 30 June 1983) were taxed at 30%. A lump sum death benefit paid to a dependant was paid tax free.

In July 1988, the government introduced a 15% contribution tax and reduced the 30% tax payable on benefits to 15%. This meant a lump sum death benefit payable to a dependant, was no longer entirely tax free because a 15% contribution tax had already been applied.

The new tax arrangement benefited members who lived long enough to enjoy the lower tax at the benefit phase but it did not compensate beneficiaries of members who died during the accumulation phase. The deceased member’s beneficiaries were detrimentally affected.

To compensate deceased members’ beneficiaries, the anti-detriment payment was introduced to restore the deceased’s death benefit to what it would have been if the 15% contribution tax had not been introduced.

The law allows dependants (i.e. spouse, former spouse, and children) of the deceased member to receive an increased death benefit, via an additional lump sum payment from their SMSF, and provides a ‘refund’ of the contribution tax paid through a tax deduction to the SMSF.

How is it calculated?

The tax deduction available to the SMSF is the anti-detriment payment amount grossed up to reflect the 15% contribution tax. This is so the reduction in tax payable by the SMSF is equivalent to the anti-detriment amount. The 15% contribution tax refund is not paid as a cash refund by the Tax Office; instead it provides a tax deduction claimable by the SMSF. For example, if an SMSF makes an anti-detriment payment of $200,000, it will be entitled to a tax deduction of $1,333,333 (i.e. $200,000 divided by 15%).

The SMSF can claim a tax deduction, which reduces its assessable income and potentially provides a tax saving equivalent to the anti-detriment amount. If the tax deduction cannot be fully used in the year the anti-detriment payment occurs, it can be carried forward to future years.

Example: Tony made concessional contributions totalling $1,000,000 to his SMSF during his membership. His SMSF paid $150,000 in contributions tax (i.e. $1,000,000 x 15% tax). Tony’s wife, Pam, would in theory be short by $150,000 plus the earnings that would have accrued over Tony’s membership period.

To reverse the effect of the contribution tax paid, an anti-detriment amount is calculated. If we assume that total earnings over the membership years amounts to be $200,000, then the anti-detriment amount payable would be $350,000 (i.e. $150,000 contribution tax paid + $200,000 potential earnings).

If the SMSF paid a lump sum death benefit to Pam that includes an additional $350,000 anti-detriment amount, then the SMSF can claim a tax deduction of $2,333,333 (i.e. $350,000 divided by 15% contribution tax).

The tax deduction can be used to reduce the tax payable by the SMSF in the current financial year or it can be carried forward to future financial years.

Most SMSFs are unable to make an anti-detriment payment, as the law states it cannot be made from the deceased member’s superannuation account. It is normally made from reserves maintained by an SMSF. SMSFs must have sufficient cash to pay the anti-detriment amount to the beneficiary.

Most SMSF accounting records do not track the contribution’s tax paid on individual members’ superannuation accounts and therefore a formula method is used to calculate the payment, based on the taxable component and service period of the deceased member. A common formula is [(0.15 x P) / (R – 0.15 x P) x C] where:

R is the total number of days in the eligible service period post 30 June 1983 up to the date of payment.
P is the number of days in component R that occur after 30 June 1988 up to the date of payment.
C is the taxable component of the lump sum death benefit excluding any insurance proceeds for which tax deductions on premiums have been claimed.

Example: Tony passes away on 15 June 2012 at the age of 60. His superannuation account balance is $1,750,000 consisting of a $1,000,000 taxable component + $250,000 tax free component + $500,000 insurance proceeds. Tony’s SMSF membership commenced on 1 July 1985. Tony’s lump sum death benefit is paid to his wife, Pam, on 1 July 2012.

Using the formula method the anti-detriment payment is calculated as follows:
R = 1 July 1985 (i.e. number of days post 30/6/1983) to 1 July 2012 = 9863 days
P = 1 July 1988 (i.e. number of days in R post 30/6/1988) to 1 July 2012 = 8767 days
C = $1,000,000 (i.e. taxable component of the lump sum death benefit)

(0.15 x 8767 days) / (9863 – 0.15 x 8767) x $1,000,000 = $153,843.90 anti-detriment amount

Pam will receive a lump sum death benefit of $ 1,903,843 ($1,750,000 + $153,843 anti-detriment amount) tax free and Tony’s SMSF will be entitled to claim a tax deduction of $1,025,626 ($153,843.90 divided by 15%).

But there’s always a twist with superannuation

Before you get too excited, let me give you a word of caution. It is the ATO’s view that any amount credited from a reserve, counts as concessional contributions (currently capped at $35,000 for those 49 years old or older as at 30 June 2014) of the deceased member unless the amount is less than 5% of the member’s account balance, before the reserve amount is allocated. Therefore, if the anti-detriment amount paid is counted against the concessional contributions cap then the tax outcome will depend on the deceased member’s circumstances.

Monica Rule is an SMSF specialist and author of The Self Managed Super Handbook – Superannuation Law for SMSFs in plain English. See www.monicarule.com.au

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One Response to Tax paid by your SMSF can be returned to your dependants

  1. Randall Kingsley February 20, 2015 at 10:48 PM #

    Thanks for the interesting note on ADPs. It has taken me while to get the idea and I suspect we are all quite different in smsf construction which makes the whole ADP idea a really individual thing.

    Consider. We are a four member smsf with two in retirement phase (aged 67, 68-designated P1 and P2), one in accumulation and using the smsf as her only super vehicle (age 33-designated A1) and the fourth member (aged 37-designated A2) although also in accumulation has a zero smsf super balance (thus far).

    The pensioners recontribution strategies a few years ago were not ‘absolute’ so we have residual taxable incomes of $68,000 (P1) and $20,000 (P2) left in our accounts.

    The accumulator (A1) has an account balance of $67,000 of which $50,000 is taxable.

    We have a reserve of $9,000 which has been 100% created by ‘robbing’ our daughter accumulator (A1).

    So by using the ATO formula to calculate a current ADP I get:

    P1 dies: ADP approx $12,000 and tax deduction potential of $80,000.
    P2 dies: ADP approx $3,530 and deduction of $23,533.
    A1 dies: ADP approx $8,825 and deduction of $58,833.

    Of course, these ADP amounts will grow as the fund grows going forward.

    Over the last five years the fund taxable income figures (after current deductions and before calculation of tax and use of dividend imputation credits) have varied between $11,000 and $25,000. So the fund could ‘currently’ benefit from an ADP generated tax deductions over several years until the deduction runs to zero-but see below.

    Now turning towards a potential anti-detriment payment in the real world, I believe the following to be a credible sequence of events:

    All things being equal, one of our two pensioners will die first. But in this scenario we are planning for the remaining partner to go onto a reversionary pension benefit and so there will be no anti-detriment payment made at that time.

    All things being equal again, our remaining pensioner dies next. At that time, an ADP can be made. But can the fund use it at that point? Will Accumulator 1 and zero trustee (A2) wind up the smsf at that point? Will zero accumulator be an active member or not at that point? Will the after death benefit payment and ADP payment render the smsf almost unviable at that point? (The smsf will go from several million dollars to just a few hundred thousand at best?)

    Should Accumulator One die first or second, then an ADP is potentially viable. This is hopefully the most unlikely in the sequence but seems to be the only reasonable condition where an ADP can be made and where the smsf tax deduction could then be ‘useful’.

    The Reserve as is, is currently able to cover an ADP for P2 and A1 but not P1. And not both P1 and P2 together. So what should be the size of the Reserve since a part ADP payment cannot be made?

    The reserve to date has unfairly ‘robbed’ A1 but this can easily be rectified by rebalancing Reserve contributions by taking proportional (wrt taxable incomes) amounts from P1 and P2 whilst making a reserve transfer to A1. A transfer (approx $5,000) will not exceed A1 super contribution limits.

    So in summary, looking at ADP and then funding a Reserve seems to be quite a technical effort and, on balance a 50-50 idea. One has to try and devine future fund earnings, time to death, potential death scenarios and trustee intentions.

    Might be just a bit too tricky for many players?

    Thanks again for the article

    Randall Kingsley

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