5 Problems with Anti Detriment Payment Strategy
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One of the most complex strategies to implement in SMSF space is paying an anti-detriment payment after the death of a member to a dependant and claiming a loss for the payment.
Background
In simple terms, when a member dies, if the trustee pays to a member's dependant, in addition to the member account, an amount equal to the contribution tax paid by the member, whilst the member was alive, the SMSF is able to claim the amount of deductible (concessional) contributions as a loss in the year of payment. This loss can be carried forward for ever and provide a tax shelter to any future deductible (concessional) contributions and taxable income.
For example, a member contributes deductible contributions of $100,000 in his lifetime from which $15K is paid in tax. At the time of his death, the members balance is $150K, for anti-detriment payment to trigger, the fund trustee must also pay an additional $15K along with the member balance of $150K to the member's dependant to claim a loss of $100,000 in the fund.
The strategy is how efficiently, the trustee is able to find the extra $15K to pay to the members dependant and how the fund is able to claim a loss of $100K ($15K / 0.15) which future members can use.
The above strategy may look simple to implement, but has its own challenges in two ways, the questions are:
1) whether the fund will have sufficient money to pay the anti-detriment amount at the time of death, and
2) whether it can fully utilise the tax deduction, post death.
Example
Anti detriment payment is explained below with a simple example.
John and Mary are in business together - They both were born only two months apart and retire at age 60. Over the years, each has contributed $500K deductible contributions. At age 60 their SMSF is valued at $2M and the two member balances are equal. Assume John dies at age 80 and Mary at age 85.
The game is that since total concessional contributions to the fund are $1M by John and Mary ($500K each) - hence if the kids (or grand kids) contribute new deductible or earn taxable income in the fund, after death, the fund (kids or grandkids) can save $150K in tax.
1) Funding the payment
Anti-detriment payments cannot be taken from other members' accounts. The SMSF fund must have sufficient capital available, elsewhere, to fund the increased death benefit.
There are two ways to fund this extra payment
a) unallocated reserves and
b) purchasing insurance cover.
a) Reserves
Reserves can be created from investment income of the fund provided it is allowed under the funds trust deed and each year documented in the funds investment strategy.
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If deductible contributions of $1M are made to the fund, by John and Mary, in the SMSF, then the reserve account should be of at least $150K. If the $2M fund earns @ 5% and if John & Mary need $80K to live on each year, only the remaining $20K can be marked for a reserve account.
Also note the anti-detriment payment must be paid in full, it's not possible to pay only a part of the anti-detriment amount the beneficiary is entitled to receive. It's either a full amount or no payment.
The first problem with this strategy is that a member may die before a reserve account is funded as it may take time to accumulate sufficient funds in a reserve from investment earnings to enable the SMSF to make an anti-detriment payment.
The second problem is that ATO is of the view that any anti-detriment payment cannot be made directly from a reserve to a beneficiary. The amount must be allocated to the member's account before any payment can be paid to the dependant.
If the allocation from a reserve is in excess of 5 per cent of the member's superannuation interest (member balance) it is counted against their concessional contribution cap.
In our case, the 5 per cent threshold will be breached, since if one member dies $75K will have to be allocated to the member which is $50K above the concessional cap, which will result in excess contributions tax of $15,750.
However if John and Mary decide to die together (say a car accident), this strategy may work as allocation from reserve should be equal and fair and reasonable to all members and member account balances.
 The third problem with this strategy is that any unallocated reserve account cannot be in pension phase, it must remain in accumulation phase. However, if income was allocated to a pension account, in absence of a reserve account - all income would be exempt from tax.
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b) Insurance
An insurance policy can be purchased by the trustee that is not allocated to any particular member; this type of insurance is debited to the operating statement.
When an insurance policy is not linked to any members' account, the premiums for the insurance policy are not deductible to the fund. Deductibility is not that important in our example as the fund is earning most of the income as an exempt pension income. However, life insurance for two 60 year olds for $150K could cost $1500 each or $60,000 over 20 years.
Also care should be taken as the trust deed must also provide the trustees with the discretion to use the proceeds from an insurance policy to make an anti-detriment payment and not automatically direct the payment to a reserve, which creates the problems outlined above.
2) Full utilisation of the tax deduction
The SMSF can claim a tax deduction by dividing the anti-detriment payment by 15 per cent. The issue we are discussing here is whether the SMSF can utilise the deduction and how long it will take to reap the benefit of the deduction.
In our example, If John and Mary decide to die at age 80 & 85 - at that point of time their daughter Lara will be 55 - 60 years and their son Steven will be 50 - 55 years old. Lara is a stay home mother and Steven will have a maximum working life of say 10 - 5 years.
On the current maximum deductible contributions of $25K each year, Steven will be able to consume only $250K of the loss plus some tax on income as one member (Mary) will be still alive and some income will still be exempt from income tax.
Some advisor may argue that Lara's kids may join the fund as John and Mary cease to be members of the fund, on death, to benefit from the loss in the fund in future financial years.
The fourth problem is that we are assuming that grand children will be able to contribute maximum deductible contributions (concessional) at an early age to take benefit of the loss in the SMSF.
Imagine Lara's child who was 5 years old when the anti-detriment strategy was implemented and are now 25 years old when John dies, become member of the fund and are now willing (and able) to contribute concessional $25K to the fund for their retirement.
The problem is that most young people are not connected with their super and may not want to contribute a higher amount then the compulsory employer's contribution.
Three other practical problems with Anti detriment payments
There are three significant issues which must be considered before implementing anti-detriment strategy.
1) Loss is eroded by exempt income
When fund earns exempt income, any loss created by anti- detriment payment is reduced by the exempt income of the fund. Each year carried-forward tax loss is reduced by exempt income and only remaining loss can only be offset against assessable income.
In our example, If John dies at age 80, and if an anti-detriment payment is paid to Mary, of $1M (John's balance) plus $75K anti - detriment payment, this will create a loss in the fund of $500K in the fund. Mary has $1M in the fund which is on pension phase and if the fund continues to earn 5% exempt income on Mary's account balance and If Mary' lives for 10 years - say to age 90, the loss will be reduced to Nil.
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This means that the SMSF may not get any value of the tax deduction for anti-detriment payment, if any members are in pension phase.
To counter this problem, Mary must exit the fund and roll over into another SMSF or a public offer fund and only accumulation phase members remain in the SMSF. For a roll over to happen, the asset must not hold illiquid assets such as property.
2. Taxable income outside SMSF
For the Anti-detriment to work, a lump must be paid to a dependant of the member. Once John's dies - a lump sum must be paid to Mary.
At age 80 she cannot contribute lump sum received as a death benefit back in the fund as a non-concessional contribution to the fund as there is a age based limit to non-concessional contributions - which means that the $1M received is invested in assets outside super which may continue to earn taxable income - on 5% income she may earn $50K each year and pay income tax and medicare levy of about $6000 after Senior Australian Tax Offset. If she lives for another 12.5 years, the $75K tax benefit in the fund is mostly eroded.
A reversionary pension may give a better result, where on John death, Mary gets John pension in addition to her own pension.
3) No - re-contribution Strategy implemented
When a fund pays a death benefit to a spouse - it does not change the tax situation of the spouse, if the death benefit contains taxable component. In our example when John dies, when a payment is made to Mary, his spouse, the taxable component of $500K will be paid out with any Tax Free component and will be tax free to Mary.
However, when Mary dies, Lara and Steven both are adult children, any death benefit payment of taxable component paid to them will attract 15% tax plus medicare levy.
Hence, along with anti-detriment strategy, the trustees must also implement re-contribution strategy whilst both John and Mary are still alive and due to restriction on how much and when you can contribute, this strategy should commence when they are 60 years old and finish before they turn 65 year old.
This re-contribution strategy is basically withdrawal of taxable component and re-contribution to the fund as a non-concessional contribution.
If John and Mary decided not to work after 60, this strategy must finish by age 65 as after this date, you cannot contribute to a SMSF unless you work for 40 hours in a 30 consecutive day period.
Conclusion
At this time there is no clear guidance from the ATO on any of the above strategies. Further, holding an insurance policy which is not linked to a specific member's account and with no intention to pay as a death benefit is contrary to the sole-purpose test.
Super funds that breach the sole-purpose test run the risk of becoming non-compliant. At this stage the ATO is concerned about only non-deductibility of these insurance premiums, but has not put forward any opinion on the sole-purpose test issue.
Trustees should ensure they obtain legal and tax advice prior to implementing these strategies. SMSF members should discuss tax consequences with their tax advisers to understand the implications for their fund prior to implementing any strategy.
Also, while emphasis is often put on the significant tax deduction that may be available, by renowned SMSF specialists, the ability for the fund to use this deduction must be considered depending on their family composition.
cial advisor, they have admitted their two kids Lara and Steven with $1000 non-concessional contributions to t
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