They say there are two certainties in life: death and taxes. Death, clear-cut. 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 per cent, plus the two per cent Medicare levy, a total tax take of 17 per cent (where insurance proceeds are included in the payment it can be as high as 32 per cent).
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- If the financial support received were withdrawn, would the person be able to survive on a day-to-day basis?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 per cent 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 per cent 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 per cent 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 per cent, 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.