SUPERANNUATION DEATH BENEFITS
How to Minimise the Superannuation 'Death Tax' for Your Children
The original intention of superannuation was to provide funds for retirement and reduce reliance on the age pension. Australians have now accumulated trillions in super assets. But what happens if you pass away leaving that wealth to your beneficiaries?
A common and painful surprise is that upon death, the Australian Tax Office (ATO) can be entitled to dip its fingers into your funds and take a significant chunk of your children’s super inheritance.
Understanding who gets taxed, and how, is the first step in protecting your wealth.
Who is a 'Dependant' for Super?
How your super is taxed on death depends on who receives it. The ATO has two categories of beneficiaries: 'tax dependants' and 'non-dependants'.
Tax Dependants: Receive the super benefit completely tax-free. This category includes:
Your spouse or de-facto spouse
Your minor children (under 18)
Anyone in an 'interdependency relationship' with you
Non-Dependants: Are taxed on a portion of the super benefit. The most common example is adult children who are no longer financially dependent on you.
An adult, independent child receiving their parent's super benefit as a lump sum will be taxed on the 'taxable component' of the superannuation. This tax can be as high as 17% or 32% (including the Medicare levy), depending on the tax components of the super fund.
This article explores strategies to help reduce this 'death tax' in the event your beneficiaries (like adult children) are not classified as tax dependants.
Strategy 1: The Re-contribution Strategy
Your super balance is made of two parts: a 'taxable component' and a 'tax-free component'.
Taxable Component: Generally built from pre-tax dollars, like compulsory employer contributions and salary sacrifice. This is the part that gets taxed when paid to a non-dependant.
Tax-Free Component: Generally built from after-tax dollars (non-concessional contributions). This part is always tax-free.
A re-contribution strategy involves withdrawing a lump sum from your super (once you are legally able to) and then re-contributing that same money back into your super as a non-concessional (after-tax) contribution.
The result? You convert a 'taxable' portion of your super into a 'tax-free' portion. This means the re-contributed funds are no longer subject to the death tax.
This strategy is most suited to individuals who have met a condition of release (like reaching age 65 or retiring after 60) but are generally under age 75 (due to contribution rules). It is constrained by the annual non-concessional contribution caps, but this can be a powerful estate planning tool when implemented over time.
Strategy 2: Directing Your Super to an Estate
Superannuation death benefits are not automatically part of your estate and don't get distributed by your Will. In most cases, the super fund trustee pays the amount directly to your nominated beneficiaries.
However, you can use a Binding Death Benefit Nomination (BDBN) to direct your super benefit to your "Legal Personal Representative" (LPR), which means it flows into your estate. Your Will then dictates who receives the funds.
While the tax rate on the taxable component remains the same, there are two key advantages:
No Medicare Levy: The 2% Medicare levy generally does not apply when the benefit is paid via an estate, offering an immediate saving.
No Impact on Beneficiary's Income: The super lump sum does not form part of the beneficiary's assessable income for the year. This is a significant benefit, as it won't affect things like their HECS/HELP repayments, family tax benefits, or the Division 293 tax for high-income earners.
Strategy 3: Withdrawing Funds Before Death
This is an option that is usually only practical in specific circumstances, such as a terminal illness diagnosis.
If you meet a condition of release (like being over 65) and are aware your health is failing, you could systematically withdraw your superannuation. Once the money is withdrawn from the super system (which is tax-free for those over 60) and held as cash in a bank account, it is no longer subject to the superannuation death tax. It simply forms part of your cash estate.
This strategy has significant implications and should only be considered with professional guidance. For example, an Enduring Power of Attorney is crucial in case of incapacitation.
How to Plan
Estate planning is complex, and superannuation law is a core part of it. These strategies depend heavily on your personal circumstances, age, and financial goals.
Consulting a financial planner can help navigate these complexities, ensuring your retirement plan is optimised and your beneficiaries are left with the most tax-efficient inheritance structure possible.
Source: https://www.morningstar.com.au/retirement/avoiding-the-superannuation-death-tax
For any further information regarding this article please call Humble Goode on (08) 7477 8252
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