Terminal illness and super

14 June 2022

Stuart Sheary

Stuart is a Senior Technical Services Manager at IOOF and is a regular presenter and author of technical literature covering tax, superannuation, social security and age care.

Clients with a terminal medical condition may withdraw all their superannuation benefits as either a lump sum or commence a super income stream regardless of their age. Accessing super under the terminal medical condition of release is one of many planning issues confronting terminally ill clients.

Accessing super under this condition of release often requires a deep analysis to achieve the most suitable client outcome. The following discusses some of the superannuation options and outcomes for clients with a terminal medical condition.

Definition

The definition of a terminal medical condition is identical under both super and tax law. This means the same criteria applies for satisfying the condition of release to withdraw from super, as well as having any lump sum payment treated as non-assessable-non-exempt income (NANE) – i.e. a tax-free payment.

A terminal medical condition is satisfied where:

  • two registered medical practitioners have certified, jointly or separately, that the person suffers from an illness, or has incurred an injury, that is likely to result in the death of the person within a period (the certification period) that ends not more than 24 months after the date of the certification;
  • at least one of the registered medical practitioners is a specialist practicing in an area related to the illness or injury suffered by the person;
  • the certification period has not ended, for each of the certificates.

Taxation of withdrawals

The taxation of a withdrawal under a terminal medical condition of release depends on whether it is taken as a lump sum or an income stream. Lump sum withdrawals are tax-free, whereas taxation on any income stream is based on the age of the member and tax components.

There are no special tax concessions on income streams commenced under this condition of release and payments are taxed according to Table 1 (below).

Table 1

Age of member* Taxable (taxed)
60 and over Nil
Between preservation age to 59 Marginal rates less 15% tax offset
Below preservation age Marginal rates

*Tax-free components are tax-free regardless of age.

Certification period

Two registered medical practitioners must certify that the member’s medical condition is likely to result in death within a period not exceeding 24 months.

This period in which the member is likely to pass away is known as the certification period. Super release forms under this condition of release ordinarily ask the medical practitioner to declare that the member will likely pass away in the next 24 months. It is possible that the medical practitioner certifies a shorter period, in which case the certification period might be less than 24 months.

Whilst other conditions of release may be available, the client may prefer to access super under the terminal medical condition of release, as lump sum withdrawals are tax-free regardless of age.

No ability to rollover

Clients with a terminal medical condition may re-evaluate the suitability of their existing super fund in the context of their changing circumstances. This may prompt them to consider rolling their funds to a new super fund. However, under reg 306.10.01 of the Income Tax Assessment (1997) Regulations 2021, a super lump sum benefit paid to a member having a terminal medical condition is specifically excluded from being a rollover super benefit.

This means if the trustee is made aware that the client has satisfied a terminal medical condition of release, tax law does not treat this amount as a rollover. However, nothing under super law prevents the funds from being transferred to another fund. As such, any transfer to a new fund during the certification period is treated as a withdrawal from the existing fund and a contribution into the new fund. This may result in an excess non-concessional contribution to the client.

If the client lives beyond the certification period, they can roll their benefits to a new fund once the certification period has expired.

If a client is in an unsuitable fund and wishes to rollover to a new fund, they may prefer delaying an application to be assessed under a terminal medical condition of release. Instead, they should consider rolling over to their preferred fund and making an application under a terminal medical condition with their new fund.

Clients should be careful before rolling super to a new fund and consider any implications insofar as loss of benefits, such as insurance cover within the fund.

Insurance

Clients may have insurance cover such as life, terminal illness, and or total and permanent disability (TPD) inside of super.

Clients should not rollover their benefits if it results in forgoing an insurance benefit. Where a client has both life and TPD cover, they should be aware of the implications of claiming on one type of cover on the other type of cover particularly if sums insured differ.

Often life insurance carries a terminal illness option allowing clients who are terminally ill to claim on their life cover early. Different policies may have different policy terms. For example, some may require a doctor to certify that the client will pass away in 12 months, rather than 24 months. This might mean that a client whose doctors believe that the client will live beyond 12 months, but less than 24 months will satisfy the terminal medical condition of release under super and tax law but fail the insurance terminal illness definition. These clients should generally delay any withdrawal until they are eligible to claim on their insurance.

During the certification period, financial planners should review the insurances within the client’s super account and ensure there is no loss of cover because of making a withdrawal or rollover from super.

TPD buy back

Clients who hold combined life and TPD cover may have a buy back option. Where they also satisfy total and permanent incapacity, they may be able to claim on TPD and if they have a buy back option, reinstate their life cover. This would allow the client to claim on both TPD and life cover.

Leave money in super to be paid as a death benefit instead?

Clients may choose to retain their benefits in super and instead leave a death benefit to their intended beneficiary, such as a spouse or child.

There are many reasons a client may not want to release super early under the terminal medical condition of release. One example might be where there is life insurance within the fund that is only paid upon death – i.e. there is no terminally ill option to claim the life insurance early.

Income stream

If the intended death benefit beneficiary is eligible to receive a death benefit income stream, then leaving funds in super may be the preferred option. Beneficiaries who may receive an income stream include:

  • Spouse;
  • Child below 18;
  • Child at least age 18 but less than 25 and financially dependant on the deceased; and
  • Adult child with disability.

Where both the deceased and the beneficiary receiving the income stream are below age 60, the taxable component of the income stream payments is taxable at marginal rates with a 15 per cent non-refundable tax offset. Where either the deceased or the beneficiary is age 60 or more, the death benefit income stream is received tax-free.

Table 2 (below) illustrates the taxation on a death benefit income stream.

Table 2

 Age of deceased Age of dependant Taxation of the taxable component – taxed element of a death benefit pension
60 or over Any age Tax-free
Below age 60 60 or over Tax-free
Below age 60 MTR and 15% tax offset. When recipient attains age 60, it becomes tax-free

 

Scenario where it may be preferable to leave benefits in super

Nick (62) is diagnosed with a terminal illness. He has a super benefit of $700,000

consisting entirely of taxable component (taxed element).If Nick dies and these benefits are paid as a death benefit super pension to his spouse

(56), the pension’s investment income and death benefit pension payments are tax-free.

His spouse can access tax-free lump sums anytime.If he takes out the benefit as a terminal medical condition lump sum and his spouse

inherits the funds, she may have to invest in her own name and pay tax at her marginal

tax rate or re-contribute part of the amount to her super, subject to contributions caps

and her total superannuation balance.

 

Lump sum

As an alternative to a death benefit income stream, the client may prefer to leave their intended beneficiary a super lump sum death benefit, either paid directly from the super fund or via the client’s deceased estate.

This option may be preferred where the intended beneficiary has an immediate cash need, such as paying off debt or where an income stream is not an option (for example, adult child beneficiaries).

The taxation on the death benefit lump sum amount paid to a beneficiary depends on whether they are a death dependant and tax components of the super payment.

Table 3 (below) illustrates the taxation on a death benefit lump sum.

Table 3

  Recipient Taxable component (taxed element) Taxable component (untaxed element)
Death benefits dependant Nil Nil
Non-death benefits dependant Maximum tax rate 15% Maximum tax rate 30%
  • The Medicare Levy of 2 per cent may also apply. Benefits paid via a deceased’s estate do not incur any Medicare Levy.

If reducing any tax on benefits paid to a non-dependant is a priority, clients may wish to withdraw all their super under the terminal medical condition of release and leave the benefits to their beneficiary via their estate. A cash inheritance paid via the estate to a beneficiary will not be taxed, unlike a super death benefit comprising of a taxable component paid to a non-death dependant. Taxable super death benefits paid directly to a non-death dependant can be taxed between 17 per cent and 32 per cent (including Medicare Levy).

A maximum tax rate of 32 per cent applies on any taxable component (untaxed element). An untaxed element is created under section 307.290 of the Income Tax Assessment Act 1997 (ITAA 1997), where a death benefit consists of insurance proceeds for which the fund claimed a deduction (which is common).

Alternative strategies

Disability

Sometimes the client may also satisfy another condition of release, such as permanent incapacity. To satisfy this condition of release, the super trustee must be satisfied that the client is unlikely to ever engage in gainful employment for which the member is reasonably qualified by education, training or experience (SISR 1.03C).

The tax concessions associated with the permanent incapacity condition of release can make this condition of release an attractive alternative to the terminal medical condition of release, particularly where the terminally ill client wishes to commence an income stream.

The tax concessions available where a client satisfies a disability payment under section 995.1 of the ITAA 1997 includes a 15 per cent tax offset on income streams (including where the client is below preservation age). In addition, a tax-free uplift is available on lump sum payments and rollovers.

To obtain the 15 per cent tax offset on a disability income stream or tax-free uplift on a commutation, the client must satisfy the tax law definition under section 995.1 which requires the client to obtain certification from two legally qualified medical practitioners that because of the ill-health, it is unlikely that the individual can ever be gainfully employed in a capacity for which he or she is reasonably qualified because of education, experience or training.

15% tax offset on disability income stream

Under the terminal medical condition of release, clients below preservation age are not entitled to a 15 per cent tax offset on income streams. The availability of the 15 per cent tax offset under the disability condition of release can make it a more attractive alternative to the terminal medical condition of release if the intention is to receive the member’s benefit as an income stream whilst they are under preservation age.

Tax-free uplift on lump sum withdrawals and rollovers

Clients below age 60 wishing to draw a lump sum will likely prefer taking a tax-free lump sum under the terminal medical condition of release. Lump sum withdrawals under the disability condition of release are taxable depending on the age of the client and components of the fund. However, where a super lump sum is drawn, or an amount rolled to a new fund, the existing fund will apply a tax-free uplift increasing the tax-free component.

Before starting an income stream, it is strongly encouraged to complete a product comparison with alternative funds to ensure they use the most appropriate product. Now may be a good time to find a more competitive product or change to a product that offers necessary features, like the ability to commence a death benefit income stream. If the client rolls their benefits to a new fund, a tax-free uplift will apply if the transferring fund holds the required certificates, and the subsequent income stream will have a larger tax-free component. This increase in tax-free component can benefit clients under age 60. The increase in tax-free component may also benefit beneficiaries below age 60 wanting to receive the super death benefit as an income stream.

Estate planning recontribution strategy

Terminally ill clients may wish to consider a recontribution strategy for the benefit of their intended beneficiaries. A recontribution strategy involves withdrawing a tax-free lump sum under the terminal medical condition of release then recontributing back into super as a non-concessional contribution. This has the potential to convert a taxable component within the fund into a tax-free component.

An increase in the tax-free component may benefit a spouse below age 60 wishing to receive a death benefit income stream or alternatively, save a non-benefit dependant, such as an adult child, tax on a super death benefit lump sum.

Social security

Clients with a terminal medical condition who receive a social security benefit may prefer to retain super in accumulation phase. Super in accumulation phase is not assessed for social security purposes until the client attains Age Pension age.

Impacted clients may consider limiting any lump sum withdrawal to amounts necessary to repaying debts or implement a re-contribution strategy.

Where a death benefit is to paid to a deceased client’s beneficiary, it is important to remember that death benefits cannot be rolled into the beneficiary’s accumulation account and must be drawn as a lump sum or a death benefit income steam. If the intended beneficiary is in receipt of social security, then a withdrawal under terminal medical condition of release and contribution into the spouse’s super fund may also be a consideration.

Conclusion

Clients with a terminal medical condition often have a lot of planning issues, including areas concerning their finances and super. Financial planners can provide significant value during this stressful period by guiding clients through these areas. Accessing super under the terminal medical condition of release is one of many financial planning issues which often requires a deep analysis to achieve the most suitable client outcome.

QUESTIONS

To answer the following questions, go to the Learn tab at moneyandlife.com.au/professionals

  1. John, age 48, has a terminal medical condition and is expected to pass away shortly. John is married to Jane who is age 68 and on a part Age Pension. Which of the following may be a reason why John might choose to leave his funds in super, rather than accessing under the terminal medical condition of release?
  1. A lump sum withdrawal may be taxable to John, depending on the components of the fund.
  2. A death benefit income stream paid to Jane will not be assessed for social security purposes.
  3. Funds in John’s super accumulation phase are not assessed by Centrelink.
  4. An anti-detriment payment may be available on a lump sum death benefit paid to Jane.

 

2. Sally, age 53, has a terminal medical condition and would like her adult daughter, Amy, to receive her super benefits. To maximise the net super amount that Amy may receive, Sally should consider which of the following?

  1. Commencing an income stream under the terminal medical condition of release and nominating Amy as a reversionary beneficiary.
  2. Withdraw a super lump sum under the terminal medical condition of release and leave Amy the proceeds via her estate.
  3. Retain funds in super and submit a binding death benefit nomination with Amy as the nominated beneficiary.
  4. Submit a binding nomination to her super fund in favour of her estate and update her Will to have the proceeds paid to Amy.

 

3. Julian, age 49, has a terminal medical condition but also satisfies the permanent incapacity condition of release. Julian might prefer to access his super under permanent incapacity (hint: assume Julian may also satisfy the definition of a disability payment under section 995.1 of the ITAA 1997) if:

  1. He would like to commence an income stream and obtain the 15 per cent tax offset.
  2. He would like to receive a tax-free lump sum.
  3. He would like to retain the option of rolling over part of any remaining super to another fund.
  4. Both a and c.

 

4. Eileen, and 52, had a terminal medical condition and subsequently passes away. She leaves $100,000 in super made up entirely of taxable component taxed element. The full amount is paid as a lump sum death benefit to her adult son. How much tax will the super fund withhold?

  1. $17,000.
  2. $32,000.
  3. Nil.
  4. $15,000.

5. Jackson, age 48, has a terminal medical condition and is expected to pass away shortly. His super consists entirely of taxable component. He withdraws $110,000 from super under the terminal medical condition of release and recontributes it back into super as a non-concessional contribution. In which of the following scenarios would a beneficiary benefit from an increase in tax free component?

  1. Jackson’s spouse who will receive a death benefit lump sum.
  2. Jackson’s spouse (age 63) who will receive a death benefit income stream.
  3. Jackson’s spouse (age 57) who will receive a death benefit income stream.
  4. None of the above.
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