|Summary: Anti-detriment payments are made by superannuation funds as an additional lump sum payment upon the death of a member. The payment is made to compensate their dependants for the fact that super contributions and income earned have been taxed at 15%.|
|Key take-out: The tax deduction that can be claimed by the super fund making the anti-detriment payment is incredibly generous. It is calculated by dividing the anti-detriment payment by 15%. This means for every $1,000 of anti-detriment payment an SMSF gets a tax deduction of $6,667. But funding a ADP can be tricky.|
|Key beneficiaries: SMSF trustees and superannuation accountholders. Category: Superannuation.|
Taxation can be a funny thing. Some tax rules seem particularly unfair. With others, you are sometimes left to wonder how legislators dreamt up something so sensible and generous.
The latter is the case with what’s known as “anti-detriment payments” (ADP), which is a payment made on the death of a super fund member designed to reclaim the tax paid on contributions over the years from the ATO, for the benefit of beneficiaries.
“What?” I heard you ask. “You can get back the taxes on your contributions?”
Well, yes, but it’s not that simple. As with anything generous, it comes with hurdles and it won’t be available to everyone.
ADPs allow a benefit to be paid out to a beneficiary, from a super fund, which then creates a big tax deduction going forward for remaining fund members to recoup the ADP payment made (which means the benefit of making the payment can be recouped for remaining members of the fund by wiping out tax payable on the fund for years into the future).
There is a reason “anti-detriment” rules were introduced, and I’ll come back to that.
That is, in essence, ADPs are designed to repay the contributions tax, and any earnings that might have accrued on that tax, on the death of a member.
Let’s say that a member has died with $200,000 in their super fund account, which has partly been created with $100,000 of contributions, on which $15,000 of contributions tax was paid. And, had the $15,000 been invested over that period, it would have created another $5000 worth of earnings.
When the fund pays out the death benefit, it would pay out $220,000, which is made up of $200,000 for the death benefit, plus an ADP of $20,000.
The $20,000 ADP payment would then generate a tax deduction of the fund of $133,333 ($20,000 / 15%) for the fund.
Extra money for the deceased member’s beneficiaries. Big tax deduction to recoup the payment for the remaining members of the fund to use in the years to come.
All sounds good, doesn’t it. But it’s not quite that simple. There is plenty of fine print to consider.
Here’s the catch ... funding the ADP
One of the main issues around ADPs is how they are funded.
When a member dies, their entire balance of their fund has to be paid out. And, in the event that an anti-detriment payment is made, the ADP payment needs to be made at the same time.
But how do you make a payment from a fund of more than the member’s full account balance at death? If the member has an account balance of $200,000, but a payment of $220,000 is required to fund the ADP at the same time, how is that achieved?
There are two main ways of doing this. The first is through the use of a reserve. The second is via insurance.
Using a reserve
Reserves within a SMSF can be used for a variety of reasons, some of which I have covered in previous columns.
Reserves need to be built over time. They can’t just magically appear. And funding them needs to be done through otherwise unallocated earnings from the fund.
An insurance policy
This also requires some planning and attention in the implementation phase. Normally, an insurance policy will be on the member and to be paid to the member’s account.
So, for insurance to be able to be used to fund an ADP, the SMSF trust deed must allow for an insurance payment to be made directly into a reserve. If an insurance policy is going to be used for this purpose, it would need to be on the life insured, but owned by the fund (and noted so) and immediately paid into a reserve for the purpose of funding the ABP.
As the insurance contract doesn’t count against an individual member’s account, it might not count as a tax deduction to the fund.
Payment needs to be made in full
In order for the fund to make the payment and therefore to claim the tax deduction going forward, the payment needs to be made in full.
That is, the fund cannot make a partial payment. Either it makes the ADP payment (in full), or it doesn’t make the payment at all.
Other things to consider
The anti-detriment payment must also be paid to a tax dependant. That is, a spouse, former spouse, or children (even adult children).
If the ADP is made, but the only other members are in pension phase, then the tax benefit could be lost, as there is no tax paid on pension fund accounts. In some cases, it might make sense for the members in pension to transfer to another fund, leaving the benefit of the tax deduction associated with the ADP for members in the fund who are paying tax.
Where it’s not useful
There are many sets of circumstances where anti-detriment payments either can’t be used, or will provide no benefit:
- Where the trust deed won’t allow this type of payment, or reserves within the fund.
- One-member funds with no reserves.
- If the death benefit is to be paid as a pension, or if the deceased has a reversionary pension.
- If the fund won’t have assessable income in future years (such as all other members are in pension).
- If the fund is to be wound up after the death benefit payment.
Check the trust deed
Your SMSF trust deed needs to allow for anti-detriment payments to be made, so this needs to be checked, or you might need to amend the trust deed.
Why do the ADP rules exist?
Prior to 1 July 1988, super funds used to be taxed at 30% on the way out of the fund. But on that date, the change was to tax at 15% on the way in and reduce the tax to 15% on the way out.
As a result, the rules were introduced to allow for the 15% contributions tax to be reclaimed, if paid out on death, which became known as the “anti-detriment” payment.
The information contained in this column should be treated as general advice only. It has not taken anyone’s specific circumstances into account. If you are considering a strategy such as those mentioned here, you are strongly advised to consult your adviser/s, as some of the strategies used in these columns are extremely complex and require high-level technical compliance.
- Under limited circumstances a SMSF fund may be able to continue paying a pension and claim exempt current pension income even when it hasn’t met the annual minimum pension payment requirements, the Australian Taxation Office says. The circumstances can be found in the FAQ section of the ATO’s website.
- The Reserve Bank of Australia (RBA), in its submission to the Financial Services Inquiry (FSI), stated SMSFs “bear close monitoring” as one of the key developments in the superannuation sector. Given SMSFs are growing at such a fast rate, the RBA is concerned that they are being exposed to higher-risk investments than they understand.
- Industry Super Australia has hit out at the SMSF sector in its submission to the FSI, calling the sector generally expensive with funds not properly diversifying their portfolio, which can have implications for systematic risk. “Data shows that 30% of SMSFs have less than $100,000 in funds under management and have costs of between 3% and 7% per year,” ISA said.
- Meanwhile, the SMSF Professionals’ Association of Australia said existing compliance based regulation for SMSFs “is working well” in its submission to the FSI. “There have been calls for SMSFs to be prudentially regulated or to be regulated as a financial product in addition to the compliance based regulation,” said SPAA senior manager Jordon George.