An individual who receives a personal injury settlement and contributes it to their superannuation may start a pension with very favourable tax treatment provided they use a separate accumulation account for the income stream but this approach will not be applicable for an SMSF , according to a technical specialist.
In response to a question posed during a recent BT Financial webinar, technical consultant Tim Howard confirmed an individual who has made a personal injury contribution could use the funds to start a tax-free pension even if they were under the age of 60.
“The contribution goes in this tax-free component because it is tax paid after tax money. We are not claiming a deduction for it, so it is not assessable income to the fund and it does not form part of the taxable component,” Howard noted.
“If we go down the line of things, it’s regarded as an additional benefit because if we start a pension with it immediately, that will quarantine it as tax-free component.
“No matter the age of the member, we are going to have pension payments that are coming from a 100 per cent tax-free component if we do our planning right. Even a client who might be in their 20s, 30s or 40s would receive the pension payments tax-free by virtue of those underlying components.”
He noted the situation can become more complex if the contribution is combined with existing superannuation entitlements that are taxable.
To illustrate his point, he shared an example involving Brad, who receives a structured settlement payment of $1.8 million and contributes it to his existing super accumulation balance of $200,000.
“Brad could have met a condition of release and used all of those funds [to start an account-based pension], but he’s decided to just use the $1.8 million to quarantine that tax-free component,” he noted.
“However, if we make the personal injury contribution to that accumulation account, then that will meld those components together and those components will be partially or majority tax-free, but certainly some of it will be taxable component.
“What we need to do is make sure we make the contribution in the first place, not into that existing accumulation account with taxable component, but actually make the contribution into a separate accumulation account.
“With an SMSF, it’s going to be a little more complicated because we can’t have separate accumulation interests in the one SMSF. So just think about that, it would need to be separate because if the components meld together, we can’t ever actually separate them.”
