Tax and Superannuation Death Benefits
Posted: October 06, 2008
With superannuation now the preferred "low-tax environment" to accumulate long-term savings, we can expect to see big increases in superannuation balances in the future.
As a consequence, superannuation death benefit payouts will undoubtedly increase, and in some cases may overtake the family home as the main Estate asset.
For dependants of the deceased, the tax situation is as simple as it can be. In the vast majority of cases the benefit will be paid tax free. In the rare cases where there is an untaxed element, it may be taxed at 15%.
However, it will become increasingly common for larger superannuation death benefits to be paid to non-dependants, usually the adult children of the deceased. If most of the payment comprises a tax-free element, this isn’t a problem. It’s a different story with the taxable (taxed) element, which will attract a 15% tax. This can make a real difference to the beneficiaries’ position, but there are solutions. Let’s look at a simple example.
Martin is 65 and has $1 million in superannuation, all a taxable (taxed) component. Should he suddenly die and the benefit be paid to his adult children, $165,000 will be lost in tax (15% plus 1.5% Medicare levy). Now if Martin had warning of his imminent demise, he could withdraw the full $1 million and, because he is over 60, it will be received tax-free. When the resulting cash passes to his children through his Estate, no tax will be payable. That’s quite an improvement from his beneficiaries’ point of view.
As with most things, some prior planning can help. People between 60 and 65 can make tax-free lump sum withdrawals from superannuation, and return them as non-concessional contributions. The funds then become part of the tax-free component. Over-65s can also use this strategy if they satisfy a work test that allows them to make further superannuation contributions. Due to the limits on non-concessional contributions, this is a strategy that needs to be implemented earlier rather than later, particularly where large sums of money are involved.
People who can no longer contribute to superannuation and have large taxable components face a dilemma. The tax-free environment of a superannuation pension is too valuable to ignore, but any subsequent death benefit may come with a significant tax liability. On the other hand, cashing out and investing outside superannuation would most likely create an ongoing income tax liability.
At the end of the day personal circumstances will determine what is required. It is therefore important for everyone over age 60 with superannuation to seek advice as to how to manage these complex issues.
Superannuation Tax Components
Superannuation may be simpler than it used to be, but some of the terminology can still be a bit confusing. Here’s a quick guide to the terms currently used to describe the tax status of different parts of a superannuation payment.
Tax-free element: This one’s easy. It’s tax free.
Taxable (taxed) element: This comprises tax-deductible contributions made to the fund plus investment earnings. These have all been taxed within the superannuation fund at a rate of 15%. In some cases, further tax may be payable on withdrawal or when paid as a death benefit (see the adjacent article).
Taxable (untaxed) element: Defined benefit funds such as some government schemes, don’t receive contributions in the normal way. Instead, benefit payments may come from a source that hasn’t been taxed. When paid from the fund, the untaxed element may be taxed at rates of 15%, 30% or 45% (plus Medicare levy), depending on individual circumstances.
