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Four ways to avoid super death benefit taxes

They say there are two certainties in life: death and taxes. Death, clear-cut, I’d agree. But with tax comes nuance, so let’s take a closer look at superannuation death benefits and tax.

In the late 1970s, death duties were abolished in Australia, although a form of them remains in relation to lump sum benefits paid from a superannuation fund where a member has died and the ultimate recipient of that payment is not classified as a 'tax dependant'. In this situation, the 'taxable' portion of the benefit payment is subject to a tax rate of 15%, plus the 2% Medicare levy, a total tax take of 17% (where insurance proceeds are included in the payment it can be as high as 32%).

How can my adult child receive my super death benefit payment tax free?

A child of any age can receive a lump sum payment directly from a superannuation fund as a consequence of the death of a member. However, an adult child will only receive the taxable component of the payment tax free where, for income tax purposes, they are either:

  • a 'financial dependant' of the deceased, or
  • in an interdependent relationship with the member, prior to the member’s death.

An adult child will receive any tax-free component of the death benefit tax free.

Dealing with interdependency first, two persons (whether or not related by family) have an interdependency relationship if:

  • they have a close personal relationship; and
  • they live together; and
  • one or each of them provides the other with financial support; and
  • one or each of them provides the other with domestic support and personal care.

On the face of it, where an adult child returns home to live, or actually never left the family home, they seem to satisfy the interdependency requirement. However, they may fall short, as the relationship needs to be more than simply one of convenience. It needs to be more meaningful, for example, when an adult child has moved home to care for an elderly or sick parent.

The other option is where the adult child is a 'financial dependent'. The ATO appears to have a narrow view of financial dependency, for income tax purposes. A number of Private Binding Rulings look at the following in relation to financial dependency:

  • where a person is wholly or substantially maintained financially by another person
  • if the financial support received were withdrawn, would the person be able to survive on a day-to-day basis?
  • if the financial support merely supplements the person’s income and represents ‘quality of life’ payments, then it will not be considered substantial support
  • whether the person would be able to meet their daily needs and basic necessities without the additional financial support.

There is also a requirement to show a reliance on regular and continuing financial support to meet their day-to-day living requirements. Finally, evidence to support the facts and the claim for financial dependency is needed, including receipts for expenditure regarding living expenses.

Not all super death benefits paid to a non-tax dependant are subject to tax

Only the 'taxable' portion of a super death benefit is subject to tax, where a person receives it who is not a dependant for income tax purposes. Any ‘tax-free’ component is exactly that, tax free in the hands of the beneficiary. The 'tax-free' component is basically made up of after-tax contributions that the member has made to superannuation. Consequently, a common strategy to ‘wash’ taxable components to tax free, prior to a member dying, is the re-contribution strategy.

Is a re-contribution strategy still relevant?

It can be. The aim of this strategy is to convert the 'taxable' portion of a member’s account balance to 'tax free'. The greater the extent of a tax-free component means less tax on benefits paid to a member under age 60 and less tax on benefits paid to a 'non-tax dependant' on death of the member.

Tax will only be applicable on a superannuation death benefit payment where:

  • A payment is made as a consequence of the death of a member; and
  • The payment is made to a person who is not a dependant for income tax purposes; and
  • The payment has a taxable component.

Four major ways to avoid the tax

As 17% can be a big tax impost on substantial balances, the following are worth considering:

  • Don’t die (I understand that medical science is working on this and making progress)
  • Make sure you have a beneficiary that qualifies as a dependant for income tax purposes at the time of death
  • Ensure 100% of your benefits form part of the tax-free component
  • Have nothing inside superannuation at the time of death.

The fourth option is especially useful, although the timing of withdrawals can be a challenge. As a person ages, particularly past 65, they can withdraw money from superannuation and hold the funds in their own name. The money will then form part of the non-super estate which is not subject to the 17% tax. However, this withdraws the funds from the tax-advantaged super system, so the personal tax implications need attention. By just considering the $18,200 tax-free threshold and assuming an assessable earning rate of 6%, that’s around $300,000 that can be held in an individual name with no personal tax (assuming no other income).

Conduct regular reviews

Given the potential for significant tax to apply in relation to a payment from a superannuation fund as a result of the death of a member, an overall estate plan review should consider intergenerational wealth transfer and preserving that wealth by reducing tax.

 

Mark Ellem is Executive Manager, SMSF Technical Services, at SuperConcepts. A more comprehensive paper on this subject is attached here. This article is general information only.

 

31 Comments
Lynette
April 06, 2021

Just a query on my personal super contributions. All of my super has come from my husbands estate, father’s estate, sale of house etc. I’ve changed super funds several times over the years. Will that be obvious at the time of my death that it is all personal contribution and no employer contribution? Do I have to make special mention of this in my estate planning so that my non dependant children receive the full amount non taxable?

Graham Hand
April 07, 2021

Hi Lynette, sorry, we are not authorised to give personal advice but in general terms, your accountant should be retaining the records on the status of your contributions. It's very important as it may determine tax treatment later.

Gene
October 09, 2020

As non-dependent beneficiary receiving a death benefit from a super fund I am wondering if the money that is distributed (which has already been taxed) to me, subject to personal income tax as well?

Monica Wang
November 11, 2020

You only pay 17% tax ( including Medicare levy) on the taxable components of death benefit distributed to you. You don’t pay additional personal income tax on the death benefit.

See: https://www.ato.gov.au/rates/key-superannuation-rates-and-thresholds/?anchor=Superlumpsumtaxtable

Peter
February 27, 2019

Can someone please advise if the following is correct.

With regards to my Super I have been advised that if I leave my Super 100% to my spouse she will not incur any tax on the amount. Also, if I have left instructions for her to then pay a percentage to my daughter and a good friend then they will not be charged the 17% tax on this amount. Is this correct?

Richard Pritchard
April 17, 2019

This may be correct but if your spouse receives the aged pension there may be consequences regarding gifting rules, you should check out Centrelink on maximum gifting and consequences for the aged pension of going over the limit, you might need to strategise around this too!

People can’t trusted
June 19, 2021

Peter, good way to try to save your daughter some tax but be warned it gives her zero legal security and your will means squat when it comes to the super you leave like this. My father did this, his wife took the whole $600k inheritance & the $1.5million house and did not give my siblings and I the 50% intended for us, she gave us zero. 2 years and $100k in legal fees later, a family is destroyed and money is lost. Don’t make your kids hate you for putting them in this position and conflict.

SARAH
September 11, 2018

My father died and he left 1.4 million in his super. Even though my step mother had her own super she fought us for the super and got 60% given to her. Then the balance was split between my brother,sister and I got the balance less 30% tax from the taxable amount. Then when I got my tax done my super inheritance was then added to my income for the year and then i was taxed at 47%.
My poor father.
He paid tax on his wage before putting it in his super. then to pay death tax, then we paid tax on his super, then we were taxed at a higher rate as it was put down as income.
My poor father.
This is a joke.

Brad Lonergan
February 18, 2019

Sarah,
The inheritance should not have been double-taxed as you have described. You may want to seek further advice to see if this was done correctly

mitchf2
June 13, 2019

@ Sarah,
You wouldn't be taxed on the "tax free" (after tax) portion of your inheritance. Also while it might look like the taxable portion was taxed at 47% there should have been a rebate against that to reduce the tax payable. As Brad said, get a 2nd opinion to see that it is handled correctly.

John
May 17, 2021

@Sarah - you shouldn't pay tax on a cash inheritance on your personal tax return. It is effectively a gift and not part of your income.

If you were advised by a tax advisor or account that you had to declare it as income, then you were misinformed and paid unnecessary tax, which you may be able to claim back.

Tracey
July 07, 2017

As an adult child receiving a death benefit from a super fund I am wondering if I also pay tax on the benefit paid? If the money comes from the super fund and they paid tax before distributing directly to non-dependent beneficiares is the amount I received subject to personal income tax? We are yet to receive a payment summary from the super fund and are keen to find out how much (if any) of the benefit they paid needs to be kept aside for a potential tax bill.

Laine
October 07, 2016

If you want to help your children with housing costs but don't want to be giving half of your money to their partner, then you could give your children an interest free or low interest mortgage.

The house still belongs to them but if it is sold the money you provided for the mortgage comes back to you in just the same way that a bank mortgage is repaid to the bank.

That way the money remains yours and returns to you if the relationship breaks up and the house is sold.

Parent of adult kids
October 05, 2016

Hi Gary, for personal reasons that is not something I would do. I don't agree that it wouldn't spoil them. The current generation of 25-35 year olds is probably the most 'entitled' generation we have ever had and to purchase them a house would only reinforce that attitude that 'someone else will bail me out'.

The bigger issue in estate planning than not leaving a tax bill is how to protect your estate from going to a partner of one of your kids when the relationship breaks up. I shudder at the thought of half of my wealth going to my children-in-law if I were to die today and their relationship broke up in a few years' time. Buying a house is practically giving half away to another family. (But that starts to reveal a bit too much detail that I don't want to go into and is the reason I've written this with a pseudonym rather than my real name.) A 15% tax rate is nothing compared to that prospect.

Gary
October 05, 2016

Hi 'Parent of adult kids', this is an excellent debate to have and thanks for your extensive comments. The article was about 'how to save taxes' but completely respect your alternative wishes to leave money to charity and be relaxed about paying taxes. Many people will feel differently and for them, the article explains how to avoid leaving a tax bill. I do think it's a fine distinction between giving the money to children during your retirement and avoiding the tax bill by giving it to them at the end of your life but let's ignore that.

One comment on giving the money to your kids early without 'spoiling' them. Say you retire at 60 and they are 30. If you have a fair amount of money and are in good health, then you might live until you are 90 and they will be 60. In my view, that's too late to help them in one crucial way that will not spoil them or compromise their independence. And that is buying a decent property in Sydney. At 30 years of age, they might want to start a family and a million dollars will buy them a small 2 bedder. Isn't it better to give them some of their 'inheritance' at this stage to set the family up for the next 30 years, rather than waiting until they don't need it? All assuming you have looked after your own expected needs, of course.

Parent of adult kids
October 04, 2016

I've been trying to think through what this means for my strategy.

Option 1 isn't as attractive as it seems. But the reason will take us into religious territory and I don't want to get into a debate with Ramani about that on a financial newsletter website.

Option 2 is totally unappealing. The last thing I would want is for one of my now married, adult kids to either be in such a parlous state that they are dependent on me, or that their children have become dependent on me.

(I take it that these two options were included only for completeness' sake, not as realistic planning proposals!)

Option 3 is a practical proposal, but assumes that I want to have funds left when I die to leave for my kids. I don't necessarily. Maybe for the education of my grandchildren, but my wife and I gave 25-30 years to each of our children before they left home, spent money on their schooling, took them travelling in Oz and other countries to show them the world, fed and clothed them, encouraged them in their career choices and basically did what we could to get them to the point where they could make their own life. So far they are on that path and they will not need my financial assistance when I pass on.

So we are leaving a chunk of whatever is left when we die to charities. We don't have as much as Bill Gates or Warren Buffett, by any means, but depending on when that happens, we will have more than our kids need. Should we die sooner rather than later (so there is quite a bit in our super), I will not give either of them an excuse to get lazy in the prime of their lives! And if we die later, well that leads to option 4.

Option 4 - leave nothing in super. If we live long enough, that's the plan. Not because we will then have a huge tax free amount outside super to leave to the kids, but because we will have used it for the purpose for which we saved it - to finance the rest of our lives. That will, by the way, include being appropriately generous to our children and grandchildren along the way, but we'll do that out of love for them, not as a clever tax minimisation scheme. Some people call this spending the kids' inheritance, but I just call it living.

So really, for me, this article probably wasn't helpful. It presumes a desired outcome that I don't share. And I doubt my kids share it either. If nothing else, they are not presuming that they'd inherit 100% of our net worth - some will go to charity, some will go in some tax. They get that. Why don't others?

Richard
October 01, 2016

Perhaps if we looked at the system as an exemption for assets received from superannuation funds for persons over 60, which is how it was announced.

We a greedy lot expecting some else to pay tax not us or our heirs

Alan
September 30, 2016

This luck of the draw basis for taxation is ridiculous. Why should one person pay many thousands in tax more than another simply because they had no idea that death was imminent?

While a morbid thought, it leaves me wondering about someone with poor quality of life who decided to self euthanase at a time of their choosing.

It seems the hope for logical, soundly reasoned policy in this country is in vain.

Laine
October 07, 2016

There are other luck of the draw taxation effects for retirees.

If you are a retired couple with $2m outside of super earning 7% giving you $70k a year each, then you pay around $31k a year in tax.

If you are a retired couple with the same amount in pension mode super you pay no tax at all.

The first couple may never have had the opportunity to put their money in super. They may have received it from selling an asset after they were 65, they may have taken their super out prior to 2007 and been too old to recontribute when the new rules came in, or they may have inherited the money after they were 65.

We need a retirement system where all retirees are treated the same regardless of whether their money is in super or not.

AJM
September 29, 2016

Hi, is it the initial tax free amount (non concessional contributions) that is not subject to the 17% tax, or is it that amount plus the earnings on that amount when paid out. Would you be able to clarify please. It could be a very substantial difference if the money has been in super for a long time. Thank you.

Mark Ellem
October 05, 2016

Hi AJM, the portion of the super death benefit that is calculated as the 'tax free' amount is not subject to the 17% tax. Whether the tax free amount is increased by earnings depends upon whether the benefit is paid from an accumulation account or a pension account. Where it is paid from an accumulation account there will be no earnings added to the tax free amount. For example, Jim made total non concessional contributions during his lifetime of $80,000 and when he died, his total super balance was $450,000, which included his non concessional contributions of $80,000 and concessional contributions from his employer(s) and earnings thereon.

Here, the tax free amount of Jim super death benefit is $80,000 and not subject to 17% tax. However, the balance, being the 'taxable component' of $370,000 would be subject to 17% tax, where it is paid to a non tax dependent, eg adult child.

Where the super death benefit payment is from a pension account, the proportion of tax free and taxable component will be based on the split of these components for the pension. Taking the Jim example, assume he was retired an commenced a pension. Say at the time of commencing his pension his balance was $380,000 and included the $80,000 of non concessional contributions. At the time of commencing his pension the split of tax free and taxable component is: $80,000 tax free and $300,000 taxable and this is converted to a percentage of 21.05% tax free and 78.95% taxable. These percentages are "locked in" for the duration of the pension.

When Jim dies and his pension balance is now $450,000 (investment return greater than pension drawdown rate), the split of tax free and taxable is determined on the original pension commencement split, resulting in a tax free portion of the super death benefit of $94,725 and taxable component of $355,275. Of course, if Jim balance was $350,000 at the time of his death, then the split would be $73,675 tax free and $276,325 taxable.

Neil
September 29, 2016

Thanks Mark,

Can you (or anyone else) please explain the actual mechanics of this tax?

That is, who declares it and when? If a death benefit is left to a legal representative (the estate) and the estate is divided between a surviving spouse and adult children, who decides who gets the super money and who gets non-super money?

Mark Ellem
October 05, 2016

Hi Neil, if the super fund pays the death benefit directly to the adult child (non-tax dependent), the fund will be required to withhold the required amount of death benefits tax. So, for example, if the death benefit payment was $100,000 and it was 100% 'taxable component' (that is, no tax free component, which is personal super contributions for which o tax deduction claimed), the super fund would be required to withhold $17,000 and remit to the ATO. The super fund would issue the beneficiary with a statement showing the gross payment and the tax withheld - much like an employee receives at the end of the year for their wages.

If, however, the super fund pays the death benefit to the Estate of the deceased, it will be the duty of the Executor(s) to withhold the relevant amount of tax. The Estate will be assessed the tax and will be required to pay to the ATO.

Deciding who gets the super money and non super money from the Estate will depend on the wording of the deceased person's Will. A properly drafted Will can allow for a super death benefit to be paid to the spouse, who as a 'tax dependent' would receive it tax free. However, the Will could be worded such that all Estate assets are proportionately distributed amongst all beneficiaries, resulting in the super death benefit being paid across both tax and non tax dependents. This is why Estate Planning is very important.

Karen Skalko
May 26, 2017

I was the opposite to this as i was the mum and my 20 year old son passed away from a car accident and he didnt have a will at the young age of 20 of course so because i was a non dependent as he didnt no longer live with me he had one hundred thousand dollars in death benefit and i had to pay Thirty three thousand in tax. Does this seem right

Carmen
September 29, 2016

Just get out of the fund provide your loved ones while alive and not when your 6feet under can't take it with you paid enough tax in my day enough is enough

Patrick
September 29, 2016

Good article Mark. With time and planning it can be avoided, a bit of luck also helps.

I do urge caution on re-contribution strategies for anyone or couple in receipt of Centrelink, especially with the announced changes whereby all withdrawal from pension phase will be income and can't be treated as a lump sum from July 2017.

Ramani
September 29, 2016

There is the existential question of whether those - like me - who believe in reincarnation ever die and are subject to earthly ATO's tax designs, deriving from the constitutional prohibition on Government making laws relating to religion (option 1 exhorting immortality). I realise Mark Ellem is not qualified to comment on Hindu and Buddhist belief, so will spare him the trouble. The mystery shall remain...

More realistically, would an enduring POA holder be able to withdraw all remaining super just prior to the saver's death when it is imminent and make it part of the non-taxable estate? Would ATO be able to attack this under Part IVA, especially if the enduring POA specifically authorises the attorney to do this?

David
September 29, 2016

This is a great topic thanks Mark.

How preposterous is it that the tax treatment of money paid to beneficiaries of an estate that includes superannuation money depends on whether the member dies quickly rather than a slow painful death that gives them time to get their affairs in order prior to carking it? Imagine if the pre-1985 CGT exemption on real property was immediately lost on the death of the property owner? There would be outcry, yet the immediate taxation penalty applied to taxable super components seems to be tolerated.

Surely the taxation treatment should be applied against the owner of the money and not the beneficiary. Once it is exempt in the owner's hands, that same status should flow through to the beneficiaries. Were it the other way around - that taxable money somehow became untaxable because of some sloppy legislative drafting it would be fixed up in record time.

Patrick
September 29, 2016

Hi David, not looking to pick a blue, but unfortunately pre-85 assets do lose their CGT free status and you instead get an assumed cost base as at date of death, (depending upon some other rules such as significant improvements etc). "If the deceased person acquired their asset before 20 September 1985, the first element of your cost base and reduced cost base is the market value of the asset on the day the person died" https://www.ato.gov.au/General/Capital-gains-tax/In-detail/Gifts,-inheritances-and-deceased-estates/Deceased-estate-and-CGT/

Greg
September 30, 2016

I guess the difference is that if the beneficiary sold the pre-85 property soon after death, its likely that there would be no capital gain and hence no CGT. So you could sell the $1M property and collect the full amount, or you could cash in the super and potentially lose up to $170K, if it was all taxable component.

Zooks
September 29, 2016

Good article and good comment.
Say you had $1m in there and half of it was taxable - and you did not get it out in time - and it the only beneficiary was a non-dependent adult child - it looks like they'd lose 17% x $500,000 which is $85,000.

Take it out in time and you do not lose it.
Hmmmm - you have to wonder, how much do you have to gain by leaving it in there? If income on the $1m was 5% (if) coming to $50,000, and if marginal tax outside the fund was 46% on that (another if) - $23,000 - and tax inside the fund 15% - $7,500 - would you need to live about 12 years before you came out in front?? as 12 x %7,500 = $90,000.
If that is right it is pretty risky leaving it in there at all.
The figures get worse if the %age which is taxable is higher - if it was all taxable the death tax would be 170K not 85K.

LIFE EXPECTANCY (ADDITIONAL YEARS OF LIFE) FOR PEOPLE AT SELECTED YEARS OF AGE
for men aged 65 it is 18.7 years - maybe this means for people between 70 - 80, keeping money in super is a bad risk for their non-dependent adult child dependants.

 

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