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Claiming a tax deduction in your SMSF for terminal illness benefits

Complying super funds are eligible to claim tax deductions for an amount paid as a death or Total & Permanent Disablement (TPD) benefit if the person terminated employment due to death or disability.

These deductions can only be claimed if the trustee elects not to claim a tax deduction for the insurance premiums in the current and future financial years.  Whilst this is available to all super funds, it is typically only claimed by self-managed super funds (as public-offer funds will typically be required to continue to claim insurance premium for its large number of fund members).

1 July 2008 saw the introduction of changes by the Liberal Government after receiving a heartfelt letter from a mother (Christina Fiddimore) who was diagnosed as terminal ill in 2005.  She desperately needed to access her super to meet the needs of her eight-year-old daughter, a mortgage, and mounting medical bills.  The Coalition quickly acted on this request and decided to change government policy on terminal illness because it believed it needed to remove as many of the stresses as possible for people who were terminally ill.

Now the recent Federal Budget proposes to allow a super fund the ability to claim a tax deduction on benefits paid to a member due to terminal medical illness.  This basically corrects an anomaly in the legislation.

The calculation for this tax deduction is the member’s total benefit (including insurance) multiplied by the member’s future service days/total service days.

I have outlined an example below to demonstrate how this works.

Example

John has a life insurance policy in his SMSF for $1,000,000.  He has been diagnosed with a terminal illness which caused him to stop working.  The insurance claim is paid into his SMSF then released to him.  His existing $420,000 super benefit is also released.  In the same financial year, the SMSF trustee paid an insurance premium of $4,000.  John is age 47 and has an eligible service period of 22 years.  The trustee can choose to claim a tax deduction for the $4,000 premium or the future service portion of the payout being $639,000 ($1,200,000 x 18 years /40 years).

By claiming the $639k tax deduction the SMSF receives a tax saving of $95,850.  Any unused deduction can be carried forward to future years.

It is important to note that the SMSF trustee will not be able to claim tax deductions for insurance premiums of the life of any members in future years.

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