The vital role of insurance in super for disability care
By Alex Denham, firstlinks.
This is a sad and true story of a young man – let’s call him Mikey – who in July 2015 at the age of 31 suffered devastating injuries whilst participating in the sport he loves, mountain biking. Mikey is now a tetraplegic, meaning his injury affects all four limbs, and with limited neurological recovery expected, he will always have a high dependency for care.
He has been in hospital in the spinal unit for many, many months and soon it will be time to go home. He is lucky to have a loving, caring family and his parents have decided to provide his long-term care in their home. Even his sister has moved back home to help.
Importance of risk insurance
Before his accident, Mikey worked as a roofing contractor, and his Super Guarantee contributions were being made to a retail superannuation fund. Mikey had saved little in his super so far, and had no other savings or assets to speak of. As luck would have it, the fund came with death and Total and Permanent Disability (TPD) cover and Mikey is now entitled to a payment of around $493,000.
Mikey’s father came in to seek financial advice on what to do with this sum. Of course, the family home needs alterations to accommodate Mikey’s care including a new bathroom off his bedroom, but Mum and Dad are choosing to fund these alterations themselves rather than pay for them out of the insurance payment.
They wish to set aside the TPD payout as a long-term investment for Mikey’s benefit in future years. They were in the process of understanding Mikey’s entitlements under the National Disability Insurance Scheme (NDIS) which is rolling out in their area on 1 July 2016. They were keen for Mikey to qualify for the Disability Support Pension (DSP) so that they did not have to draw on the TPD payment for his living expenses.
A financial plan for a person with a disability
What should they do with the $493,000 so that it can be invested for the long term, but accessible if needed without affecting the DSP which of course is means tested? Investing the money in Mikey’s own name means it will be subject to the Income and Assets test and cut into his Government benefits.
A Special Disability Trust (SDT) is a trust established to pay for any disability care, accommodation, medical costs and other needs of the qualifying beneficiary during their lifetime. It comes with social security benefits in that the balance up to $636,750 is exempt from the Assets Test, so it would meet the requirement to maximise Mikey’s DSP.
However, there is one major hurdle. SDTs are specifically intended for succession planning by parents and immediate family members for the current and future care and accommodation needs of a person with a severe disability or medical condition. As such, only immediate family members can contribute to it and Mikey is not able to contribute himself as the beneficiary.
No SDT for Mikey. If in future Mum and Dad wanted to set one up for him and gift their own assets to it, it can be considered down the track.
The solution is actually remarkably simple: keep it in super in the accumulation phase, but roll it to a new fund. The payment from the new fund will be classified as a ‘disability superannuation benefit’. A formula is applied to the payment to calculate a tax-free component, and in this case it will be a significant amount, around $479,000.
The remaining $14,000 is a ‘taxable’ component, taxed at 21.5% if and when he withdraws it from the superannuation system as a lump sum.
For more information on how disability superannuation benefits are taxed refer to the ATO site here.
As Mikey has met the ‘total and permanent incapacity’ condition of release, he can access the money at any time. Lump sums will be withdrawn in proportion to the tax-free and taxable components, and taxed accordingly.
Best of all, as he has left it in accumulation phase (as opposed to starting an income stream), and he is under his age pension age of 70, it is exempt from the Income and Assets test and he qualifies for the full rate Disability Support Pension which is tax-free.
Super is, in fact, a very tax-effective and flexible vehicle to hold money for those who are young and suffer permanent incapacity. There’s no need to go fiddling around with complex trusts. Although it is worth noting that the recent super announcements in the Federal Budget – namely the $500,000 lifetime limit on non-concessional contributions – puts the brakes on being able to contribute large compensation payouts to super.
In Mikey’s case, once he moves home to his parent’s house, they will meet the interdependent relationship definition. This means that they are treated as each other’s dependants for both tax and superannuation purposes. Mikey will do a non-lapsing binding nomination to his parents, and if he predeceases them, the money passes to them tax-free. As he has no other assets, this negates the need for him to do a will.
The ripple effect of this terrible accident runs wide, and has changed the lives in this entire family. Mikey’s Dad needs to cut down his working hours from full time to part time to care for Mikey. He is in a defined benefit super fund, with the end benefit paid being based on a formula relying on a multiple (including part-time adjustments) and Final Average Salary. Cutting down his hours is going to cost him in terms of his own retirement benefit.
But imagine the position Mikey would be in if a) he didn’t have such a loving, supportive family and b) he didn’t have the insurance cover in his super fund. It’s a strong argument for compulsory insurance cover in super for the young.