The Federal government passed a number of measures last year to help consolidate superannuation funds which could dramatically increase the tax paid by some super fund members by thousands of dollars.

If a member was paid a total and permanent disability (TPD) benefit under super, they would only pay tax on a portion of the lump sum. The tax-free component is the portion of the eligible-service period, that is the date they joined the fund and or employer until age 65, that they are considered TPD.

However, if a member rolled over a super account from earlier employment, the new fund inherits the earlier eligible service period start date. This means that the taxable component is greater.

In a recent case study, a superannuation fund member’s tax liability increased from $4,000 to $125,000 because of a rollover.

She was a member of a retail superannuation fund, having joined in 2016 after she started work. The fund included a TPD insurance benefit of $1.1 million. Unfortunately, she developed a chronic and debilitating neurological condition, ceased work in 2017 at aged 40 and successfully claimed the TPD benefit.

However, instead of paying $4,000 in tax for the short period she was a member of the fund, she was shocked to learn that the tax was assessed at $125,000 because she had rolled over $1,600 from an old superannuation account which she opened in 1997.

This unfortunate and unintended outcome will be played out many times with the auto consolidation of inactive and small accounts which has been turbocharged by recent amendments to superannuation laws.

It will inhibit the ability of people whose working lives are cut short because of disability to have sufficient retirement incomes. It is also not consistent with the policy setting of the concessional tax treatment of invalidity benefits which is designed to encourage workers to self-insure for their retirement.

A no-disadvantage test for invalidity payouts following account consolidations would deal with the problem.

Legislative reform is needed urgently to fix this unintended tax slug.

John Berrill is a partner at law firm Berrill Watson

Join the discussion