Anti-detriment deductions are the most powerful – yet least understood – superannuation strategy available. This is mainly due to lack of education on the subject.
Luckily, anti-detriment deductions are actually straightforward. This article seeks to provide a solid foundation for financial planners wishing to be able to add value to clients using anti-detriment deductions.
Prior to July 1, 1988, contributions to super funds were not subject to income tax. From July 1, 1988, employer contributions to super funds have been subject to income tax, at the rate of 15 per cent.
When this change was introduced the then treasurer, Paul Keating, said that the Government did not want to “tax the dead”. Accordingly, a mechanism was introduced to ensure that no detriment would be suffered by children and spouses of a deceased person. That mechanism was the “anti-detriment deduction”.
How it works
The anti-detriment deduction provisions are currently contained in sections 295 to 485 of the Income Tax Assessment Act 1997 (Cth). Prior to July 1, 2007, they were contained in section 279D of the Income Tax Assessment Act 1936 (Cth).
Upon a member’s death, the anti-detriment deduction encourages super funds to “top up” the deceased’s benefits. Specifically, the legislation provides that the super fund can claim a deduction if it implements the following steps:
- Upon a member’s death the super fund pays out a lump to a spouse or child of the deceased.
- The super fund increases that lump sum by an amount so that the lump sum is the same size it would have been if no tax on contributions were payable.
If the super fund implements these steps, it can claim a deduction calculated as the size of the increase divided by 15 per cent. This is best explained with a simple example. Dad’s employer contributes $20,000 to a super fund on behalf of Dad.
Dad then dies. If there was no tax on contributions, the super fund would have $20,000 to pay to Dad’s spouse or children. However, from July 1, 1988, the $20,000 is subject to income tax at a rate of 15 per cent.
Therefore, upon Dad’s death only $17,000 (that is, $20,000 less $20,000 x 15 per cent) is sitting in his member account. The detriment that his spouse or children would suffer is the difference between:
- what they would have received if contributions had never been made subject to income tax; and
- what is sitting in Dad’s member account in the fund upon his death.
Accordingly, in this scenario, the detriment that the spouse or children would suffer because of the tax on contributions is $3000 (that is, $20,000 less $17,000). Therefore, if the super fund tops up any lump sum payment to the spouse or children by $3000, so they receive $20,000, the fund can claim a deduction of $20,000 (that is, $3,000 divided by 15 per cent).
This is great news for the spouse or children. They might have only been expecting to receive $17,000, but instead they receive $20,000.
Real life issues
For financial planners wanting to implement anti-detriment deduction strategies in real life, several key issues must be considered.
1. Not all super funds do it
There is no express legislative requirement for a super fund to “top up” a death benefit and claim the anti-detriment deduction. Practically speaking, it is voluntary for a super fund. Although some super funds choose to do it, many do not.
Financial planners may wish to contact their clients’ super funds to determine whether upon death they will top up death benefits for anti-detriment deductions. There have been instances where clients have died and their super fund was not going to top up the death benefit amount.
However, where the client had a switched-on financial planner who was willing to “kick heads”, the super fund has been convinced to pay it out.
2. Self managed super funds
All complying super funds – including self managed super funds (SMSFs) – are able to claim anti-detriment deductions. The biggest question for SMSFs is where to find the top-up amount from.
The most common answer is reserves. However, many SMSFs do not maintain reserves. There are other ways to fund the top-up amount; but to discuss them here would be beyond the scope of this article.
3. How to calculate the detriment amount
In the above example, it was easy to essentially “audit” the deceased’s contributions and determine the detriment due to tax on contributions. However, in real life, several factors make this more complicated:
- What if the fund no longer has records of all contributions?
- What if the member had made contributions to another fund and then rolled them into that fund?
- What if no actual tax had been payable because franking credits et cetera were available?
- Does the missed growth on tax paid also constitute detriment?
There is no official legislated method under which the detriment amount must be calculated. There are multiple different methods, but it’s often up to the super fund to decide whether or not to use them.
The most popular method for non- SMSF super funds involves a formula. A word of caution about this formula: engaging in a withdrawal and recontribution strategy significantly reduces the size of the top-up amount calculated under this method.
Naturally, clients with SMSFs have more flexibility in choosing which method to use to calculate the detriment amount.
4. Must be a lump sum
The death benefits must be paid by way of a lump sum for the anti-detriment deduction to be available. It is not available where death benefits are paid by way of pension.
Putting it all together: case study
Consider the following. George, age 65, dies on November 1, 2009. His eligible service period commenced in 1990. He has $730,000 of member benefits in his SMSF (of these benefits, $280,000 is the “taxable component”).
The SMSF has reserves of $50,000. The SMSF calculates George’s detriment amount to be $49,412. If the SMSF pays a death benefit lump sum to George’s spouse or children of $779,412 (that is, $730,000 plus $49,412), it can claim a deduction of $329,413 (that is, $49,412 divided by 15 per cent).
The SMSF could use this $329,413 deduction to offset any capital gains arising when paying out the death benefit, future assessable contributions to the SMSF and any other future assessable income of the SMSF.
Anti-detriment deductions can allow for spouses and children of a deceased to receive significantly more from super than they otherwise would have. Furthermore, the deductions can be used to offset large amounts of assessable income.
Various issues must be considered before and during the implementation of an anti-detriment deduction strategy. A financial planner who can “get it right” can add huge wealth to clients and has a powerful string in their bow.
For the full calculations behind the case studies used in this article, please email the author at [email protected]