A guide to understanding TPD benefits from super

Advisers play an important role in helping clients with a debilitating illness or injury and unable to work, to claim their super for financial support.

Most APRA funds offer income protection insurance - salary continuance cover - designed to replace part of the income of an ill or injured member who cannot work.

Salary continuance payments start after a waiting period, e.g. 30, 60, or 90 days, has been served and the insurer has approved the claim. Typically, benefits are paid monthly; backdated to the end of the waiting period.

But if a client is ill or injured to the extent they can't work in any job ever again, a total and permanent disability (TPD) benefit from their fund can provide financial help in paying medical and rehabilitation costs, debt repayments and supporting the future cost of living for them and their family.

Accessing super under TPD can be daunting, so here's a methodical approach to it.

Meet Homer

Homer, aged 50, is unable to work due to an accident that's left him permanently disabled.

He started at Springfield Nuclear Power Plant (SNPP) at age 35.

In the SNPP Super Fund, Homer has a balance of $200,000 (employer contributions with earnings) and $800,000 TPD insurance cover.

Homer needs his super, so he makes a TPD claim with the trustee.

1. Insurance

Most APRA funds offer TPD insurance, and many include it automatically.

Payouts are determined by the fund's policy with TPD insurance paying a lump sum benefit where a member becomes totally and permanently disabled because of illness or injury.

Insurers have different definitions of what it means to be totally and permanently disabled but in super it covers members where they're unable to ever work again in any job suited to their education, training or experience, i.e. "any" occupation.

This cover is less likely to pay out than an "own" occupation policy - where a client is unable to work again in the job they were working in before their disability.

Super funds only have "own" occupation policies where they were in place before 1 July 2014.

Homer's TPD claim is approved by the insurer, so insurance proceeds are paid into the SNPP Super Fund, increasing his balance to $1 million.

2. Can Homer access his super?

Superannuation law restricts fund members from accessing benefits until they have met a "condition of release".

With Homer, the permanent incapacity condition of release must be satisfied before he can access his super.

Homer's benefits may be cashed where he's ceased working and the trustee is satisfied that he's unlikely, because of ill health, to engage in gainful employment that he's reasonably qualified for by education, training or experience.

This is consistent with "any" occupation insurance cover. Where a fund holds an old "own" occupation policy, insurance proceeds may be locked in super.

The trustee is satisfied that Homer meets the permanent incapacity condition of release, so his $1 million benefit may be cashed as a lump sum or used to commence a pension.

3. Does Homer's payout receive concessional tax treatment?

Taxation law determines the tax treatment of super benefits.

From age 60, all benefits - lump sums and pensions - from taxed super funds are tax-free.

Under 60, the "taxable component" of a benefit is taxed; the "tax-free component" is tax-free.

Where benefits are taken as a lump sum, the taxable component (taxed element) is taxed at a maximum rate of 22% including Medicare levy.

With a pension, that component of each payment is taxed at marginal rates.

If Homer is suffering from ill-health (physical or mental) where two medical practitioners certify it's unlikely he'll ever work again in a job he's reasonably qualified for, his benefits will be concessionally taxed as a "disability superannuation benefit" under tax law.

Lump sum benefits get an uplift in the tax-free component, and the taxable component of pension payments receive a 15% tax offset.

The tax-free uplift - additional tax-free component - represents future service forgone between his date of disablement (date unable to work) and age 65, and is calculated only upon crystallisation of the benefit, i.e. on payment of a lump sum benefit or rollover to another fund.

It is not available where the benefit is paid as a pension.

But Homer may rollover his benefits to another fund to commence a pension, thereby getting "the best of both worlds" - the tax-free uplift and 15% tax offset on taxable pension payments.

The new fund will receive his benefits non-preserved with the tax-free uplift - the trustee of the SNPP Super Fund having determined that Homer met the permanent incapacity condition of release, and the benefit was a disability super benefit.

However, the new trustee will need to make its own determination in treating any benefit payment as a disability super benefit - it cannot rely on what the former trustee did.

So, Homer needs to establish this with any new fund he may rollover to.

The medical certificates given to the SNPP Super Fund may be used provided they're not too old - the new trustee applies a 'use by date' and, if they're more than two or three years old, will require new certificates.

Homer wants a pension and has found a better fund to provide this, so he rolls his benefits over to Moe's Super Fund.

The SNPP Super Fund treats the rollover as a disability super benefit, so it gets a $500,000 ($1 million x 15 years future service forgone / 30 years total service period) uplift in the tax-free component. It was nil before the rollover.

In Moe's Super Fund, Homer commences a pension drawing $80,000 with a taxable component of $40,000 ($80,000 x $500,000 / $1 million). The pension qualifies as a disability super benefit, so the 15% tax offset wipes out the tax and only Medicare levy of $800 is payable.

If Homer had taken this pension from the SNPP Super Fund, the entire $80,000 would have been taxable with tax and Medicare levy being $4,388 (after 15% tax offset).

If Homer had an SMSF, the process would be no different but as trustee, he would need to be extra diligent and as bona fide as possible, given he's making decisions in respect to his own circumstances.