Alternate deduction a big tax win

tax SMSF deduction

A substantial tax advantage can be enjoyed by SMSF trustees should they decide to use the alternate deduction method for risk insurance premiums.

A technical expert has reminded advisers that using the alternate deduction rules with regard to risk insurance premiums can create a significant tax advantage for an SMSF.

The alternate deduction provision is unique to SMSFs and allows trustees to claim future deductions relating to risk insurance held within the fund when the member the policy covers dies before the age of 65.

“Unfortunately the opportunity arises out of a set of tragic circumstances where a person has passed away, they’ve passed away before 65, and the cold hard facts of this alternate deduction is the younger they die, the bigger the deduction,” Accurium head of education Mark Ellem told delegates at the recent selfmanagedsuper SMSF Professionals Day 2022 held in Sydney.

To illustrate the advantage of using the alternate tax deduction rules, Ellem used the example of an SMSF member who passes away at age 44 with total super benefits of $1.5 million, which includes a life insurance policy of $800,000.

Premiums for the year were paid monthly and total $2816 or $352 for eight months.

Using the formula provided by the law, the total assets of the deceased member are multiplied by a proportion of the individual’s future service period determined by the years they would have been able to work had they reached the age of 65 – the standard age of retirement.

In this situation, the deceased member’s current service period is 25 years, or 9125 days, and their future service period is 21 years, or 7665 days. The calculation of the alternate deduction is then determined by multiplying $1.5 million by 7665 divided by the person’s full service period to age 65 or 16,790 days.

“The calculation gives the fund a tax deduction of $684,783. That’s a real tax benefit of $102,717. That’s $684,783 of assessable income that the fund won’t pay tax on going forward,” Ellem noted.

“Now obviously all of that’s not going to be used in that year, the member’s not going to have $684,000 worth of income … but compare that to the tax benefit from simply claiming the insurance premiums of $2816.”

He pointed out this opportunity is unique to SMSFs and that the insurance premiums for the risk cover have to have already been made in the year of the member’s death for this strategy to be used, and as such recommended trustees pay monthly amounts as opposed to a yearly one.

Further, no other deductions can be claimed for insurance premiums in the future once the remaining trustees have decided to use the alternate deduction rules.

“If you have the tragic circumstances of someone in the fund passing away before 65 and they’ve got insurance, considering this alternate deduction could provide their legacy to their family members that they don’t pay tax in the fund for a number of years,” he said.

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