An SMSF that has a working member who dies before age 65 and who held insurance cover paid through the fund may be able to benefit from a strategy that can reduce tax applicable to future fund earnings and assessable contributions, according to an SMSF technical expert.
SuperConcepts SMSF technical services executive manager Mark Ellem said his firm had received an ATO private binding ruling (PBR) that indicated under certain conditions SMSF members could claim a future service deduction (FSD) where remaining, and future, fund members would pay no tax on future employer contributions for a number of years.
Ellem said the tax strategy was not well known and contained an “unpalatable” component – the death of an SMSF member before the age of 65 who held life insurance via the fund.
He said the an FSD was an alternative approach to claiming a deduction for life, total and permanent disability or income protection insurance premiums paid on policies that covered a member in the event of a superannuation death benefit, a disability super benefit or a temporary disability benefit paid in the form of an income stream.
“An alternate to claiming a tax deduction for the actual insurance premiums is the option of claiming a deduction for the future liability to pay benefits based on the actual cost of providing the death or disability benefits which arise in each year,” he said in a column on the SuperConcepts website.
“The general understanding is that the alternate FSD is available if the SMSF trustee chooses not to claim a deduction for the cost of death or disability insurance premiums in respect of that year and the fund pays a superannuation death or disability benefit in consequence of a member’s termination of employment, or pays a benefit because of a temporary inability to work.”
Under the FSD, if the trustees of an SMSF elect not to claim the insurance premium paid for a year and instead choose to claim a tax deduction under the future service liability deduction provision, the deduction amount is based on the benefit amount multiplied by the difference between the date the member stopped working and the age of 65 and the total time they have worked until that age.
The amount resulting from this deduction is taxed at the fund’s tax rate of 15 per cent and if the fund does not have enough taxable fund income to offset this deduction, it can be carried forward.
Ellem used an example of a fund member who died at 42 and was employed at the time of death after having started work in 2000, resulting in a current service period of 20 years and a future service period of 23 years, up to age 65.
The member also held $600,000 of life insurance and an accumulation balance of $700,000, for a total death benefit payable of $1.3 million
“If the SMSF trustee(s) elects not to claim the insurance premium paid for the year and instead choose to claim a tax deduction under the alternate future service liability deduction provision, the deduction amount is calculated as $1.3m x 23/43 = $695,349,” Ellem said.
“Using the fund’s tax rate of 15 per cent, the tax benefit to the SMSF is $104,302. If the fund doesn’t have enough taxable fund income to offset this deduction, it can be carried forward.
“Rather than the fund claiming for the insurance premium, the SMSF has claimed a deduction of $695,349.”
The fund could not claim any deduction in the future for insurance premiums, however, the SMSF would have to earn $695,349, after allowable deductions, before it would start paying any tax. That includes assessable employer and member contributions that are directed to the SMSF.
“Again, that’s $104,302 of actual tax that the fund will not pay on net assessable investment income and assessable contributions – take that to the bank!” Ellem said.