Estate planning: Beware the dastardly death tax

Although superannuation death benefits are tax-free when paid to dependants, a “death tax” continues to apply when super monies are paid to non-dependants.

Any of your children aged 18 or over, who can’t prove they were dependent on you financially, or can’t prove they have an interdependent relationship with you, are deemed not to be “dependants” under the tax laws, even though they are a dependant under the super laws. What this means is that they can still receive a death benefit from your super fund or estate, but the benefit is taxed.

Non-dependants under both superannuation laws and tax laws can also receive a superannuation death benefit, usually after a super fund pays a benefit to a person’s estate.

Dependant definition: A dependant under the tax rules automatically includes a fund member’s heterosexual spouse (and same sex spouse since 1 July 2008) and his or her children who are aged under 18. An adult child, or anyone else for that matter, can be deemed to be a dependant under the tax rules if they can prove they were financially dependent on the deceased fund member or they had an “interdependent relationship” with the deceased. An interdependent relationship is a close personal relationship between two people who live together, where one or both provides for the financial and domestic support, and care of the other.

The level of tax payable on lump sums paid to non-dependants depends on the components that make up the death benefit. A death benefit can be made up of a taxable component and a tax-free component, or just one of these components.

In taxed schemes (90% of fund members belong to such schemes), the deceased’s tax-free component is tax-free, but the taxable component will be subject to 15% tax plus Medicare levy when paid to a non-dependant.

In untaxed schemes (many long-term public sector fund members), the deceased’s tax-free component is tax-free, but 30% tax will be payable on the first $1.205 million (for the 2011/2012 year), and the top marginal tax rate (45%) plus Medicare levy on any death benefit above the $1.205 million.

Note: Lump sum benefits paid to dependants are tax-free when paid from taxed schemes or untaxed schemes. Lump sum benefits paid to non-dependants via the deceased’s estate are subject to the ‘death tax’ but are not subject to the Medicare levy.

I explain the rules applying to death benefits, and strategies to minimise the ‘death tax’ in more detail in my book DIY Super For Dummies (Wiley).