Estate planning for clients with a terminal illness can provide a useful benefit at a time of sadness. When a super fund member is terminally ill, they may be able to receive a tax-free lump sum from their fund. Many funds also offer the early payment of a death benefit insurance in the event of terminal illness. In this article we explore some of the estate planning opportunities and potential pitfalls of terminal illness benefits.

Condition of release

A member’s benefit can be released if the member has a terminal medical condition which is defined as:

  1. two registered medical practitioners have certified that the member suffers from an illness, or has incurred an injury, that is likely to result in the member’s death within the certification period that is no more than 24 months after the date of the certification
  2. at least one of the registered medical practitioners is a specialist practicing in an area related to the illness or injury
  3. for each of the certificates, the certification period has not ended.

In practice, medical practitioners tend to make the certification period the full two years. However, in the event that a practitioner had provided a shorter certification period it is important to ensure that the specified period has not elapsed.

Preservation

The member benefits that have accrued up to the time of meeting the condition of release become unrestricted non-preserved. Any additional benefits accrued by the member during the certification period also become unrestricted non-preserved benefits.

Any benefits that accrue after the certification period ends are not covered by this condition of release and are therefore preserved.

Insurance

Many insurance policies allow a member to claim a death sum insured in the event that they meet the terminal medical condition of release. There is generally no further ability to claim in the event of death or permanent disability.

Prior to 1 July 2015, the terminal medical condition certification period was 12 months. Although the condition of release extended the period to 24 months, many insurance policies are only increasing the period in their policy definitions when policies are renewed. Accordingly, some members with a 24 month certification period may not be able to claim insurance benefits.

Payments

The tax treatment of a terminal illness benefit depends upon how the benefit is paid.

Lump sum payments

A lump sum payment made during the certification period is tax free, regardless of the member’s age.

Any balance remaining after the certification period ends will be taxed as an ordinary member benefit where tax will depend upon the member’s age.

If a member previously applied for a benefit under another condition of release and PAYG tax was deducted, the member may provide the trustee with the terminal illness medical certificates. The certificates must state that the member satisfied the terminal medical condition definition at the time the original payment was made, or within 90 days from receiving the payment. The trustee may then request a refund of the PAYG tax deducted and make an additional payment to the member.

Claiming a tax-free terminal illness benefit can assist clients who have non-tax dependant adult children as the likely recipients of a death benefit. A death benefit paid to an adult child will be taxed at 17% of the taxable component. An amount paid as a terminal illness benefit can be withdrawn tax free and gifted to the children before death or paid as non-super monies via the estate (and therefore not subject to tax).

Pension payments

If the member elects to receive a pension benefit, the benefit is taxed as a normal superannuation pension, there are no tax concessions for a terminal illness pension.

Rolling over

Although superannuation law allows a terminal illness benefit to be rolled over to another fund, such rollovers are not rollover superannuation benefits under tax law. If a terminal illness benefit is rolled over, the transfer is not treated as a rollover but as a personal member contribution.

The paying fund is treated as having paid a benefit to the member for tax purposes and the member is deemed to have been paid a tax-free lump sum. The receiving fund is then treated as having received a personal contribution from the member.

The amount will therefore count towards the member’s concessional and/or non-concessional contributions cap, depending on whether they may have been eligible to claim a tax deduction for some of the contribution.

If a member is wanting to move their benefit to another fund, they may consider rolling over to the new fund and then applying to receive the benefit as a terminal illness benefit from the new fund. However, this may be detrimental if the existing fund offers terminal illness insurance.

Some funds may allow a member to claim insurance under the terminal medical condition and then process a rollover under a permanent incapacity condition of release.

Avoid the pitfalls of rolling over

Understanding the requirements to claim a terminal illness benefit may assist clients with their tax planning and avoid the potential pitfalls of rolling over.