A TPD claim through super has two steps most people only see as one. First the insurer pays the benefit into your superannuation account. Then you decide how to take it out. Tax is charged at the second step, and the amount depends on your age, the make-up of your account, and whether you take a lump sum or an income stream. Getting this right can change the outcome by tens of thousands of dollars, and it is a decision to make with advice before withdrawing anything.

Key points

  • The insurer's TPD payment into your super account is not taxed on the way in.
  • A withdrawal for permanent incapacity is a disability superannuation benefit: the tax-free component is increased to reflect the years you would have worked to age 65.
  • The remaining taxable component is taxed at up to 22 per cent (including Medicare levy) if you are under your preservation age, and at lower or nil rates at or above it.

The tax-free uplift

When a super benefit is paid because of permanent incapacity, and two medical practitioners have certified that you are unlikely ever to work again in a job for which you are reasonably qualified, the tax law increases the tax-free portion of the benefit. The formula takes the period from the date you stopped work to your 65th birthday as a proportion of your total service period, and treats that proportion of the benefit as tax-free in addition to any tax-free component already in the account. The younger you are when the incapacity occurs, the larger the uplift. The certification wording matters, and the fund needs it before it pays.

The taxable component

Whatever remains after the tax-free component is the taxable component, made up of a taxed element (contributions and earnings already taxed in the fund) and, in some funds, an untaxed element. If you take a lump sum under your preservation age, the taxed element is taxed at 20 per cent plus the Medicare levy. From preservation age to 59 a low-rate cap applies, and from 60 the taxed element is tax-free. An untaxed element is taxed at higher rates.

Lump sum or income stream

A disability benefit can also be taken as an income stream. Under preservation age, the taxed element of an income stream is taxed at your marginal rate with a 15 per cent tax offset; from 60 it is tax-free. For some people, particularly those well under preservation age with a large benefit, an income stream or a mix produces a better after-tax result than a lump sum. For others, a lump sum to clear debt or fund treatment is the priority. This is a financial planning decision as much as a tax one, and the fund's own advisers or an independent adviser should run the numbers before you choose.

What is not taxed

The compensation you receive in a CTP, WorkCover damages or public liability claim is not assessable income; nor is a WorkCover statutory lump sum for permanent impairment. TPD is different only because it passes through the super system.

Centrelink

A lump sum withdrawal counts as an asset, and an income stream counts as income, for Centrelink purposes. If you receive the Disability Support Pension or JobSeeker, the timing and form of the withdrawal can affect it, and Centrelink should be told.

Frequently asked questions

Is a TPD payout tax-free in Australia? Partly. The tax-free component is increased for permanent incapacity, but the taxable component is taxed if withdrawn under your preservation age, at up to 22 per cent on the taxed element.

Do I have to withdraw the TPD money from super? No. It can stay in the fund, be taken as an income stream, or be withdrawn as a lump sum, in whole or in part. The choice affects the tax.

What is the preservation age? Between 55 and 60 depending on your date of birth; 60 for anyone born on or after 1 July 1964.

Sources

  • Income Tax Assessment Act 1997 (Cth), ss 301-10 to 301-40 (tax on superannuation lump sums and income streams by age), 307-145 (modification for disability benefits — the tax-free uplift) — legislation.gov.au
  • Australian Taxation Office, Tax on super benefits — ato.gov.au
  • Australian Taxation Office, When you can access your super early (permanent incapacity; two medical practitioners) — ato.gov.au
  • Services Australia, How lump sums and super affect your payment — servicesaustralia.gov.au