Making the most of your client’s TPD payout through super [CPD Quiz]

01 July 2019

Mark Gleeson

Mark Gleeson CFP® is Technical Services Manager at Insignia Financial. He has 20 years’ experience within the...

This article explores how to manage Total and Permanent Disablement (TPD) payments through superannuation.

This article outlines how to manage Total and Permanent Disablement (TPD) payments through superannuation. As most financial planners only occasionally provide advice in this area, it’s important to refresh your knowledge of the technical rules to help you develop a sound plan for your client.

We explore lump sums, income streams and other options to maximise social security payments. A key consideration post 1 July 2017 is the transfer balance cap of $1.6 million (financial year 2018/19).

Accessing a TPD benefit through super

To access a TPD payment from a super fund, your client must initially satisfy the insurance policy’s definition of TPD. If the policy was in place before 1 July 2014, the TPD definition could vary from the current definitions.

For example, the policy may have an ‘own occupation’ definition, ‘homemaker’ definition or a ‘modified’ TPD definition. If the policy definition is satisfied, the proceeds are paid from the insurer and added to the client’s super balance. At this point, the insurance proceeds will increase the super fund’s taxable component.

To access money as a lump sum or income stream, the permanent incapacity condition of release, or other condition of release, must be satisfied.

Permanent incapacity occurs when a client has physical or mental ill-health and the trustee is reasonably satisfied that they are unlikely to engage in gainful employment for which they are reasonably qualified by education, training or experience. The fund trustee generally requests medical certification from two legally-qualified medical practitioners when making the assessment.

Form of a TPD benefit

If the permanent incapacity definition is satisfied, the amount in the super fund becomes an unrestricted non-preserved component. This simply means that the funds can be accessed as a lump sum, income stream, or a combination of both. Furthermore, the funds can remain in the accumulation phase of super indefinitely. Many clients only consider taking the lump sum, but it is important to assess other strategies that may be more tax-effective or increase social security payments.

The lump sum option

If a lump sum is paid from the fund, the amount of tax payable depends on the super components and the client’s age.

If the client is under preservation age, which ranges from age 57 to 60, depending on their date of birth, the taxable component adds to their assessable income and is taxed at a maximum rate of 20 per cent plus Medicare levy.

For clients who are between preservation age and under age 60, the taxable component is added to assessable income, with nil tax up to the low rate cap of $205,000 (2018/19) and a maximum rate of 15 per cent plus Medicare levy thereafter.

From age 60, the taxable component is received tax-free. The tax-free component is received tax-free, regardless of age.

Tip: Watch out for the addition of the taxable component of a super lump sum to assessable income if your client is under age 60, as the outcome could impact their entitlements or obligations related to income, for example, family tax benefits, co-contribution, child support obligations and division 293 tax.

There is an additional tax concession provided to a lump sum or rollover, known as a disability super benefit. The tax-free component is increased if the benefit is paid because of ill-health and two legally-qualified medical practitioners certify the client is unlikely to be gainfully employed in a position for which he or she is reasonably qualified due to education, experience or training. The super fund’s trustee must obtain two certificates to increase the tax-free component. The fund’s trustee would normally have already requested these details for the permanent incapacity assessment.

The tax-free component of the benefit is increased to broadly reflect the period the member would have expected to be gainfully employed. The existing tax-free amount in the super fund is increased by an amount which is calculated as follows:

Days to retirement: Number of days from the day on which the person stopped being capable of being gainfully employed to their last retirement date.

Last retirement date: If a person’s employment or office would have terminated when he or she reached a particular age or completed a particular period of service – the day he or she would reach the age or complete the period of service (as the case may be); or in any other case, the day on which he or she would turn 65.

Service days: The number of days in the service period for the lump sum.

Example: Lump sum and increased tax-free component

Archana, age 45 (date of birth 23 January 1974), has $100,000 in super (all taxable component) with any occupation TPD cover of $900,000. Archana sustains an injury and triggers the payment of the TPD cover into her super fund. An amount of $1 million now sits within the account, all as a taxable component. She requests her super fund’s trustee to release the benefits under permanent incapacity and provides two medical certificates. She wants to receive the full amount as a lump sum and to understand the tax consequences if the payment date of the lump sum is 1 May 2019.

The start date of Archana’s fund is 11 April 2009. The trustee generally assumes a person would retire at age 65, that is, 23 January 2039 for Archana. After applying the formula above, the trustee calculates the increase in the tax-free component as follows:

  • Service Days = 3,672 (11 April 2009 → 1 May 2019)
  • Days to retirement = 7,208 (1 May 2019 → 23 January 2039)


$1 million – $662,500 = $337,500.

Therefore, the remaining amount of the lump sum is $337,500 and is all taxable component – element taxed.

As Archana is under preservation age, the taxable component of $337,500 is added to assessable income and taxed at a maximum rate of 22 per cent. This results in $74,250 tax payable and a net benefit of $925,750. To reduce Archana’s tax payable, she could consider retaining part of the benefit in the accumulation phase or commencing an income stream. Furthermore, she could rollover the benefit to another provider and request the trustee (of the original fund) to increase the tax-free component.

In hindsight, if Archana required a net lump sum benefit of $1 million, the sum insured should have been grossed up to allow for the tax payable.

Tip: When including TPD insurance within super, you may want to select a fund for your client with a later start date to increase the future service period and increase the tax-free component.

The income stream option

An account-based pension option paid from the super fund is particularly tax-effective in cases of TPD due to the tax-free earnings within the fund and tax concessions on pension payments. A client receiving a disability super income stream before reaching their preservation age receives a 15 per cent tax offset on the taxable component of each pension payment. The tax-free component is tax-free. From preservation age, the account-based pension is taxed normally.

Example: Income stream option

 Let’s continue the example of Archana from before. Instead of receiving the full $1 million benefit as a lump sum, Archana decides to take $400,000 to clear her debts and commence an income stream with the remaining amount of $600,000 (all taxable component).

The income stream commenced from Archana’s fund is simply an account-based pension. The pension has a minimum payment of 4 per cent (as Archana is under age 65) and the earnings within the account-based pension are tax-free. The taxable component of payments receives a 15 per cent tax offset. Lump sums can be accessed at any time, with any tax payable being based on the components. The transfer balance cap is not a problem for her, as the commencement value is below $1.6 million.

In short, the tax treatment of the account-based pension compares favourably to alternative investments available to Archana.

From 1 July 2017, a key consideration is the transfer balance cap of $1.6 million (2018/19), if part or all of the benefit is received as a disability super income stream. This cap applies on the total amount that is transferred from accumulation to pension phase.

When a disability super income stream is commenced, a credit applies in the transfer balance account. For existing pensions at 30 June 2017, the closing balance on that day is the credit in the transfer balance account. Amounts withdrawn from the disability pension as a lump sum, or rolled over, create debits against the transfer balance account.

If the credit for the client’s income stream, plus the credits for any other pensions already owned by the client, exceed the cap, then the client has an excess transfer balance problem. The amount above the cap, plus associated earnings, must be removed from the pension. This can be done either as a roll-back to accumulation or as a lump sum, however, excess transfer balance tax applies.

Tip: If an account-based pension is commenced from the super fund that received the TPD insurance, the trustee would not increase the tax-free component using the disability super benefit formula. However, if the super fund is rolled over to another provider, the trustee should increase the tax-free component. This strategy may be useful to increase the tax-free component before commencing an account-based pension with the preferred provider. Caution is warranted when doing this because multiple rollovers or contrived arrangements may be considered tax avoidance.

Retain funds in super option

Another option for TPD is to simply leave the funds in accumulation phase where a maximum 15 per cent tax applies on fund earnings. Lump sums can be withdrawn from the unrestricted non-preserved component as needed, but be mindful of the tax consequences outlined before. Any earnings growth within the fund forms part of the preserved amount.

From a Centrelink perspective, any amount held in the accumulation phase of super is not assessed under the assets test or income test when the individual is under Age Pension age. In contrast, the amount in the accumulation phase of super is assessed, tested and deemed under the income test from Age Pension age.

The favourable assessment below Age Pension age may allow your client to retain some of the money in the accumulation phase of super and apply for the Disability Support Pension, if they are eligible.

Amounts held in account-based pensions are fully assessed under the assets test. Any new account-based pension commenced from 1 January 2015 is deemed under the income test. Certain account-based pensions commenced before 1 January 2015 remain grandfathered under the income test.

Example: Retaining benefits within super

Archana, from the previous examples, wants to consider applying for the Centrelink Disability Support Pension as a single homeowner. Let’s assume she satisfies the eligibility criteria (e.g., residence and medical requirements) and has $30,000 in other (non-deemed) assessable assets. If she commences an account-based pension with $600,000 as suggested before, Archana has total assessable assets of $630,000 and exceeds the upper asset threshold of $567,250. Therefore, under this option, she receives no amount of Disability Support Pension.

Alternatively, if she commences an account-based pension of $400,000 and leaves an amount of $200,000 in the accumulation phase, then her assessable assets reduce to $430,000 under this option. Now Archana can receive $411.70 per fortnight, or $10,704.20 per year in Disability Support Pension. The amount held in accumulation phase of super is not assessed until Archana reaches age 67 – her Age Pension age.

In establishing the appropriate mix of accumulation phase and account-based pension money, consider the additional tax payable on the amount held in accumulation phase against the favourable Centrelink assessment. Each case should be assessed on its own merits. 

Comparing the options

Table 1 summarises what you need to consider for the strategies we have detailed. In practice, a combination of two or more options may satisfy the client’s objectives.

 Table 1

Strategy Considerations for clients
Client receives super benefit as a lump sum ·       Clear debts and meet up-front expenses, for example, paying for modifications to their home.

·       Significant tax may apply under preservation age (up to 22 per cent tax on taxable component). Between preservation age and under age 60, the taxable component above the low rate cap is taxed at up to 17 per cent.

·       The tax-free component should be increased by the fund.

Client commences an income stream ·       Satisfy ongoing expenditure requirements.

·       Tax-free earnings within the account-based pension.

·       Tax-effective income if under age 60:

o   15 per cent tax offset on the taxable component.

o   No tax on the tax-free component.

·       Tax-free income from age 60.

·       Transfer balance cap of $1.6 million (2018/19) applies.

Client retains funds in super ·       Tax-effective environment, maximum tax of 15 per cent on fund earnings.

·       Super is not assessed under Centrelink means tests if under Age Pension age.

·       May claim Disability Support Pension (if eligible).

·       A partner may apply for Carer Payment and/or Carer Allowance if they provide care.

Tip: A relatively unknown strategy may be available to assist self-managed super fund (SMSF) members upon death or disability. Generally, SMSFs can claim a tax deduction for disability insurance premiums. However, in the event of a member’s disability, the trustee may decide not to claim a deduction for the premiums and instead claim a more significant deduction based on a legislated formula known as a future service deduction.


David (50) and Celeste (48) are trustees of their own SMSF and have two young children. David has an accident on a skiing holiday and now has a permanent disability. He terminates his employment arrangement. His balance in the SMSF is $500,000, with an additional $1.5 million TPD cover. The total premiums paid by the fund for insurance is $4,000 (for both members).

Given that his total benefit is $2 million, David commences an account-based pension up to the transfer balance cap of $1.6 million and leaves the remaining $400,000 in the accumulation phase. In the current financial year, the SMSF can claim the $4,000 premium as a tax deduction or an amount of the future liability to pay benefits using the legislated formula:

Benefit amount x Future service days

Total service days

The formula is similar to the tax-free component increase for a disability super benefit. ‘Benefit amount’ in this formula includes a lump sum or commencement of an income stream. Let’s assume there are 5,478 days between the date of termination of fund membership (age 50) to age 65. There are 12,783 days in the total service period (age 30 to 65).

The future liability tax deduction is: $1 million x 5,478/12,783 = $428,538

Accordingly, the SMSF can claim a tax deduction of $4,000 or an alternative tax deduction of $428,538 in the current financial year. If the SMSF has a taxable income of $28,000, a carry forward loss of $400,538 is created. The carry forward loss can be used to reduce future taxable income of the fund, which may include amounts such as taxable contributions, capital gains and other investment income from accumulation interests. A disadvantage is that any future life/TPD premiums cannot be claimed by the SMSF as a tax deduction. However, the fund can claim the future service deduction for other members.


There are significant advice opportunities for clients who receive a TPD payout into their super fund. Clients may be keen to take a lump sum from super, but the tax payable may be substantial.

A lump sum sufficient to satisfy immediate needs can be a good option combined with an account-based pension to provide ongoing income.

The transfer balance cap should be considered before commencing an income stream. Retaining some funds in the accumulation phase may assist a client maximise their Disability Support Pension.

SMSF trustees also have a unique opportunity afforded by the future service deduction, which should be carefully considered.

Mark Gleeson, Senior Technical Services Manager, IOOF TechConnect.



Take the quiz here.

1. Which of the following best describes the tax treatment of a lump sum from super in the case of TPD?

a. Lump sums are received tax-free.

b. Lump sums before age 60 are received tax-free.

c. The disability super benefit increases the taxable component of the lump sum.

d. The taxable component under preservation age is added to assessable income and taxed at a maximum of 20 per cent plus Medicare levy.


2. Which of the following is true when considering Centrelink means testing for the Disability Support Pension?

a. Assets in the pension phase are not assessed before Age Pension age.

b. Assets in the pension phase are not assessed from Age Pension age.

c. Assets in the accumulation phase are not assessed before Age Pension age.

d. Assets in the accumulation phase are not assessed from Age Pension age.


3. Jim, age 52, has a disability and the TPD insurance is paid into his super fund. Jim decides to leave the amount in the accumulation phase. His transfer balance account will have a credit. True or false?

a. True

b. False


4. Which of the following is true about the future service deduction strategy?

a. The SMSF can claim both the insurance premium and the future service deduction in the year of benefit payment.

b. The SMSF can claim either the insurance premium or the future service deduction in the year of benefit payment.

c. The SMSF can claim neither the insurance premium nor the future service deduction in the year of benefit payment.

d. The strategy should be used in retail funds, rather than SMSFs.


5. Which statement is the most correct if the permanent incapacity condition of release is satisfied?

a. A lump sum can be received tax-free, regardless of age.

b. The super becomes unrestricted non-preserved component.

c. A lump sum can be received with some tax payable from age 60.

d. The super becomes restricted non-preserved component.