Key Highlights

•  The superannuation test requires the trustee to be reasonably satisfied the member is unlikely ever to work again in a role they are reasonably qualified for.

•  The tax definition sets a higher bar, requiring two legally qualified medical practitioners to certify it.

•  Trustees are encouraged to obtain both certificates and record their decision and evidence in minutes.

When a member of a self-managed super fund suffers a serious illness or injury, the trustees, who are often family members, may be asked to release benefits quickly. Permanent incapacity is a recognised condition of release, but a specialist educator has warned that trustees should hold themselves to a higher evidentiary standard than the superannuation rules alone appear to require.

At The Tax Institute's National Superannuation Conference in Melbourne, Accurium head of SMSF education Mark Ellem highlighted a gap between the superannuation definition of permanent incapacity and the tax definition, and recommended trustees meet the stricter of the two in all cases.

Two definitions, two purposes

The superannuation test in regulation 1.03C of the SIS Regulations requires the trustee to be reasonably satisfied that the member's ill health, whether physical or mental, makes it unlikely the member will ever again engage in gainful employment for which they are reasonably qualified by education, training or experience.

The tax definition in section 995-1 of the Income Tax Assessment Act 1997, relevant to the tax concessions on disability super benefits, sets a higher bar. It requires two legally qualified medical practitioners to certify that, because of ill health, it is unlikely the person can ever be gainfully employed in a capacity for which they are reasonably qualified.

Ellem's recommendation was that trustees obtain the two medical certificates regardless. He said members who want the tax concessions need them, and that auditors, and possibly the ATO, may require substantiation beyond a trustee's own determination. He suggested auditors would likely expect evidence that meets the tax definition.

Why the trustee's satisfaction is not enough on its own

In a large fund, an incapacity claim is assessed by the trustee's claims team, often with insurer involvement and independent medical review. In an SMSF, the trustee may be the member's spouse or the member themselves. That makes it difficult to demonstrate that the trustee's satisfaction was reached objectively.

If a benefit is paid without a valid condition of release, it may be treated as illegal early access. The ATO's guidance on conditions of release says trustees must be satisfied the member has met a condition of release before releasing any funds, check that the fund's governing rules allow the release, and keep records and proof that all requirements were met. It notes that the auditor will check that no benefits were illegally released, and that illegal early release can lead to administrative penalties and possible disqualification of trustees.

The same guidance describes permanent incapacity as applying where the member has ceased gainful employment and the trustee is satisfied that, because of ill health, the member is unlikely to engage in gainful employment for which they are reasonably qualified. Once that condition is met, the ATO lists no cashing restrictions, so the benefit can be taken as a lump sum or an income stream. Temporary incapacity is different: the ATO says it is generally payable only from insured or employer-funded benefits and must be paid as an income stream, not a lump sum.

Practical considerations for trustees

Trustees handling a possible permanent incapacity claim can take several steps:

  • check the trust deed for any specific requirements about incapacity benefits and how they are assessed;
  • obtain two certificates from legally qualified medical practitioners addressing the tax definition, even if the trustees are already satisfied;
  • record the trustees' decision in minutes, explaining the evidence considered;
  • consider whether the member's education, training and experience have been taken into account, since the test looks at employment for which they are reasonably qualified;
  • check whether the fund holds insurance for the member and whether the insurer's own process applies; and
  • confirm how any lump sum or income stream will be taxed before payment, and whether the member is better served by a lump sum or a pension.

Where the evidence is not yet sufficient, trustees should not release the benefit early simply because the family needs cash. There may be other options, such as a temporary incapacity income stream where insurance and the deed allow, or a release on another ground that the member already satisfies.

Hypothetical example

A hypothetical 54-year-old electrician suffers a spinal injury and cannot return to his trade. His wife, the other trustee, is satisfied he will never work again. Before releasing his balance, the trustees obtain reports from two medical practitioners addressing whether he can ever be gainfully employed in a role for which he is reasonably qualified, including office-based work drawing on his trade experience. The reports, the trustees' minutes and the payment records are kept together for the auditor.

Takeaway

Permanent incapacity can open access to super when members most need it, but the evidence must stand up to scrutiny. Following the approach recommended by Accurium's Mark Ellem, obtaining two medical certificates that address the tax definition, gives trustees, auditors and members greater confidence that the release is valid and correctly taxed.