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