Tax-free Payout

Most retail lump sum benefits paid outside super are tax-free under section 118-37 of the Income Tax Assessment Act 1997. Income protection monthly benefits are the main exception.

When cover is held inside super, the tax treatment depends on the benefit type, the member's age, and the beneficiary's relationship to the member.

Tax treatment by benefit type

| Benefit | Held personally | Held inside super | |---|---|---| | Life (death benefit) | Tax-free to any beneficiary | Tax-free to tax dependants; up to 17% on the taxable component to non-dependants | | TPD lump sum | Tax-free | Generally tax-free if permanent incapacity condition is met | | Trauma lump sum | Tax-free | Rarely held in super | | Income protection monthly | Taxable as ordinary income | Taxable as ordinary income |

The income protection treatment exists because the monthly benefit replaces income that would have been taxed if earned through work. Premiums are deductible, benefits are taxable, and the two cancel out across the policy.

Worked example: $500,000 TPD lump sum

• Setup: retail TPD policy, paid personally, no super involvement
• Tax payable: $0
• Net to recipient: $500,000

Compare this to ordinary income of $500,000, which would attract roughly $200,000 in tax at the top marginal rate plus Medicare Levy. The tax-free treatment is what gives a lump sum its full economic value.

Super death benefits: tax dependants vs non-dependants

Super death benefits paid to tax dependants (spouse, child under 18, financial dependant, or interdependent) are tax-free. Benefits paid to non-dependants (typically adult children) are taxed at 15% plus 2% Medicare Levy on the taxable component. See Death Benefit Tax for the full calculation.