Super Inheritence

Written by Michael Hutton, Published by AFR.

Just because there is no inheritance tax doesn’t mean you don’t have to protect your beneficiaries.

While Australia doesn’t have an inheritance tax, there are still a number of taxes that are triggered by a person’s death.

One that many people seem unaware of is the superannuation death benefits tax. It’s becoming more of an issue as people live longer and have more wealth.

That it isn’t often payable contributes to the lack of awareness.

In most situations, super death benefits are paid to a dependent and are therefore tax-free. In these circumstances, a dependent includes a spouse and a child under 18. As super is paid to a surviving spouse in most cases, there is no tax liability.

Likewise, any super benefits withdrawn by the member themselves, while alive and over 60, are not taxable.

The tax liability arises when the super balance is to be paid upon death to adult children or other non-dependent beneficiaries.

In this case, recipients will need to pay a tax of 15 per cent on the “taxed component” of the amount they receive. This could be up to $150,000 per $1 million paid out, plus Medicare levy of a further two per cent. The Medicare levy can be avoided if the lump sum death benefit is instead paid to the deceased’s estate, as estates don’t use the Medicare system.

To gauge the impact of the tax, first consider whether there are qualifying dependants who have been nominated to receive any lump sum.

If there are no qualifying dependants, or a death benefit is to be paid to others, the next step is to determine the level of the “taxed component” within the super fund, as it is this component of the benefit payment that the tax would be levied on. The taxed component is essentially what is left after payouts of tax-deductible contributions plus earnings of the fund over its lifetime.

Conversely, the “tax-free component” of a super benefit is essentially the remainder of the after-tax (non-concessional) contributions that have been received by the fund.

The taxable and tax-free components are generally recorded on the annual member statement provided by the super fund. Sometimes the tax-free component is a large proportion of the benefit, which helps significantly reduce the impact of the 15 per cent death benefits tax.

The government’s mooted $3 million soft super cap – over which an extra 15 per cent tax is to be applied to earnings – has also put more focus on the super death tax.

Some people are considering reducing their super balances to avoid breaching this cap. By taking money from a super account and investing it elsewhere, people are also reducing future exposure to the death benefits tax.

Of course, this presupposes that people are eligible to take money from their super account. Typically, this means that they have reached their preservation age and terminated employment, or they have reached 65.

Withdrawing from a super account also needs to make sense in the overall financial situation.

Some issues to examine include:

  • Any impact on asset protection and estate planning arrangements if reducing the super balance.

  • The alternatives for reinvesting any money taken out of super. Options include establishing a personal portfolio or a joint portfolio, or perhaps a family trust or a personal investment company. But it may be best to leave the balance in super and have beneficiaries liable for some tax upon receipt of a lump sum death benefit at some point.

The big, unanswerable, question is of course, how much longer will I need my super for?

We had a client suffering ill health who believed he wouldn’t live much longer. He decided to take all of his super out and invested the money personally. He ended up living a further five years and paying a lot more tax than if he hadn’t rearranged his affairs.

This is why it’s always important to consider all the options and implications before making wholesale changes based on one eventuality.

Brad Stewart