An individual can use a payment arising from a structured settlement or order for personal injury to contribute those funds to super outside the contribution caps.
The recent passing of legislation to allow persons over age 64 to make downsizer contributions using a portion of the sale proceeds of their home from 1 July 2018, provides an avenue to contribute funds into super without having the contribution assessed against either the concessional or non concessional contribution (NCC) cap.
There are a few other circumstances where a client can contribute funds to super outside contribution caps. One of those is a payment arising from a structured settlement or order for personal injury which will be explored in this article.
An eligible payment
A number of criteria must be satisfied in accordance with the Income Tax Assessment Act (ITAA) 1997 section 292-95 for a payment to be eligible to be contributed to super and excluded from the NCC cap.
Essentially, there are three ways the contribution can arise under the ITAA 1997 section 292-95:
The payment is settlement of a claim for compensation or damages for or in respect of personal injury suffered by you, based on the commission of a wrong or right created by statute. Settlement must be by written agreement between the parties;
The payment is settlement of a claim in relation to personal injury suffered by you under State or Commonwealth law in relation to workers compensation; or
The payment arises from a court order in respect of a claim for compensation or damages in respect of personal injury, based on the commission of a wrong or right created by statute.
The legislation also requires that two legally qualified medical practitioners certify that, because of the personal injury, it is unlikely the client can ever be ‘gainfully employed in a capacity for which they are reasonably qualified because of education, experience and training’.
Note that this certification does not generally need to be provided to the super fund at the time of contribution. However, it should be retained by the client and readily available, for example, should the Australian Taxation Office (ATO) seek this information.
Compensation payments not in respect of personal injury cannot be contributed to super under this exclusion. If a payment was made, which included both payment for personal injury and payment for another remedy (for example, compensation or damages for loss of property), only that part identified in either the court order or settlement agreement as being payment solely for personal injury, can be contributed to super under the personal injury exclusion. If the claim is not separated, the entire amount will not qualify for the contribution cap exemption.
The client should be advised to seek legal advice where there is difficulty determining what part of a compensation payment is in respect of personal injury and any portion that is not.
Making the contribution
Once it is determined that a payment is eligible to be contributed to super under the personal injury exemption, this must be done by either the client or their legal personal representative (LPR) and using the approved form.
The ‘Contributions for personal injury election’ form can be found on the ATO website.
In completing the form, the client or their LPR must make a declaration that the payment is eligible to be excluded from the NCC cap, as it satisfies all the criteria set out under the ITAA 1997 section 292-95. Penalties apply for false and misleading statements, so it’s important the client seeks tax or legal advice if they are unsure.
The form must be completed and provided to the super fund at the same time or before the client makes the relevant contribution. The notification will not be valid if the form is provided after the contribution is made. This would result in the contribution being reported as a non-concessional contribution, and included in the client’s total super balance. This may lead to a breach of the non-concessional contribution cap. The contribution would also, in this instance, count under the transfer balance cap if transferred to a retirement pension.
A valid contribution is viewed as a personal contribution and forms part of the tax-free component of super. If otherwise eligible, the client may be entitled to the Government co-contribution as a result of the contribution.
Timing is important and to receive the cap exemption, the contribution must be made within 90 days after the latter of:
receipt of the payment from which the contribution will be made; and
the day on which the court order was made or written agreement for settlement entered into.
Note that in some circumstances, the Commissioner may allow a longer timeframe.
If a tax deduction is claimed for any part of the contribution, this amount becomes a concessional contribution and will count against the concessional contribution cap.
Once the contribution is made
An eligible contribution does not count under the NCC cap and is deducted under the definition of a client’s ‘total super balance’. The contribution is also not assessed against the transfer balance cap, through a debit created at the latter of when the contribution is made and when the client first commences having a transfer balance account.
Whilst the contributions will be preserved, due to the extent of injuries, the client can often satisfy an early condition of release, such as permanent incapacity. Importantly, satisfying the trustee that the client meets the permanent incapacity condition of release in line with the super fund’s Trust Deed is a separate and additional process from making the personal injury contribution.
Wes is injured in a car accident and two qualified doctors have assessed that as a result of his injuries, he is unlikely to ever be gainfully employed in the capacity for which he is qualified.
On 4 January 2018, he receives a settlement for personal injury for $800,000, which he would like to use to generate a regular income stream to meet his cost of living. With the assistance of his financial adviser and lawyer, he determines that a super contribution using the proceeds of the settlement will qualify for the personal injury exemption and that he will be able to satisfy a condition of release to commence an income stream.
Wes needs to complete the ‘Contributions for Personal Injury’ ATO form and provide this with or before making the contribution of $800,000 to his super fund before 4 April 2018.
What about compensation paid not in respect of personal injury?
Any payment received that is not in respect of personal injury, cannot be contributed to super under this exemption. However, a client can still contribute these funds into super by making a non concessional and/or concessional contribution. Naturally, people aged 65 to 74 need to meet the work test prior to contributing and caution needs to be taken to ensure the relevant contribution cap is not breached.
When calculating the 30 June total super balance for the purpose of the next year’s NCC cap, it is important to remember to exclude any eligible contribution made under the personal injury exemption. However, any earnings on the initial contribution will be included in the balance.
Lana, age 50, receives a compensation payment of $900,000 under a court order on 1 February 2018. Her lawyer advises that $500,000 is in respect of personal injury and can be contributed to super under the cap exemption.
Lana needs to complete the ‘Contributions for Personal Injury’ ATO form and provide this with or before making the contribution of $500,000 to her super fund before 2 May 2018.
In July 2018, she has $325,000 remaining from her compensation payment in her bank account, which she wants to contribute to super. Her ‘total super balance’ at 30 June 2018, after deducting the $500,000 contribution under personal injury, is $1.2 million. She could therefore contribute up to $300,000 as a non concessional contribution by triggering her three year bring forward period. Assuming she had sufficient taxable income to offset, she could also use up to $25,000 to make a personal deducible contribution.
The total balance of her super benefits following these contributions is now $2,025,000.
Her super fund, after assessing her claim against its Trust Deed requirements, advises that Lana satisfies the permanent incapacity condition of release and all her benefits are now unrestricted non preserved. Lana elects to transfer her accumulation balance into an account based pension. This results in a credit to her transfer balance cap of $2,025,000 and a simultaneous debit of $500,000 in respect of the personal injury contribution. Therefore, the overall credit on her transfer balance account of $1,525,000 is within her transfer balance cap.
Note: Once a person starts to have a transfer balance account, when calculating the ‘total super balance’ at 30 June, a modified transfer balance cap is used, which ‘adds back’ the personal injury contribution debit. For example, assume at 30 June 2019, the balance of Lana’s account based pension is $1,900,000. Her total super balance would be $1,400,000 calculated as:
Accumulation phase = $0
Plus Modified transfer balance account = ($2,025,000 – $2,025,000 + $1,900,000) = $1,900,000
Less structured settlement contributions = $500,000
Receiving a compensation payment may have implications for a client’s existing or future Centrelink benefits.
The Social Security Act 1991 (SSA) definition of compensation requires the payment to be made ‘wholly or partly in respect of lost earnings or lost capacity to earn resulting from personal injury’. This includes payments from a workers’ compensation scheme, and personal injury compensation payments.
One of the underlying principles of Australia’s social security benefit system is that individuals who are unable to work due to injury – and have received a compensation payment in that regard – are not able to receive Centrelink payments at the same time.
This means that many Centrelink payments, including Age Pension, Disability Support Pension and NewStart Allowance, are affected by compensation payments.
Receipt of a lump sum compensation payment will generally preclude payment of the relevant Centrelink payment for a period of time. To determine the number of weeks the client cannot receive any Centrelink payment, Centrelink will divide the compensation part of the lump sum payment by the weekly cut off limit for a single rate pension under the income test that applies at the date of settlement.
Angelina receives a lump sum payment of $500,000 at 1 December 2017 and $250,000 is determined as relating to lost earnings (i.e. the compensation part). Her Centrelink payment preclusion period is 255 weeks, from 1 December 2017 to 21 October 2022, calculated as:
$250,000 / $978.40 = 255 weeks.
If taken into account in a preclusion period, the lump sum will not count under the Income Test for future payments. Any lump sum will count under the Assets Test, unless invested in a Centrelink exempt asset (such as super for those under Age Pension age).
For the Low Income Health Care card, the gross amount of a compensation payment is assessed as income. A lump sum will be apportioned over 12 months to produce a weekly amount.
Making a contribution from a personal injury settlement into super may allow eligible clients to contribute an uncapped amount into super and potentially commence a tax-effective income stream.
However, it is prudent when providing advice to a client about making contributions to super from personal injury payments to recommend the client seek specialist legal advice to ensure they satisfy all the requirements under the ITAA section 292-95.
In addition, confirmation should be sought from the super fund about its requirements to release the benefits to minimise the risk of the client not meeting a condition of release and being unable to access their benefits.