If you plan to leave your super to your adult children when you die, your death benefit may be hit with benefits tax, even though you would have received that benefit tax-free (if aged 60 or over) while you were alive.
The reason for this inconsistency is that death benefits paid to individuals who are considered non-dependants under the tax laws, such as financially independent adult children, can be subject to a special ‘death tax’.
If your death benefits are paid to an individual considered a dependant under the tax laws, however, no tax is payable on the benefit. Officially this type of dependant is known as a “death benefits dependant”. Death benefits dependants (that is, dependants under the tax laws) include your spouse, children under the age of 18, any individuals (including adult children) who are financially dependent upon you, or any individuals (including adult children) who have an interdependent relationship with you.
Now, the rules can be confusing because a financially independent adult child is considered a dependant under the super rules, which means he or she can receive the benefit from the super fund, but is considered a non-dependant under the tax laws (that is, not a death benefits dependant) which means that the taxable component of the super benefit paid to your daughter or son will be taxed.
In plain English, what this means is: if any of your children aged 18 or over can’t prove they were dependent on you financially, or prove they have an interdependent relationship with you, then they are considered non-dependants under the tax laws, even though they are considered dependants under the super laws. Your financially independent adult children can still receive a death benefit from your super fund or estate, but the benefit is taxed.
Note: Generally, your dependants under the superannuation laws, or your legal personal representative, are the only people who can receive a death benefit directly from your superannuation fund. An individual who isn’t your dependant under the super laws, may receive your death benefit but, usually, that can only happen when the death benefit is first paid to your estate. If you have no dependants, your death benefit is paid to your estate.
What are the tax implications for a ‘non-dependant under the tax laws’?
A superannuation death benefit may consist of a
- Tax-free component. This component is always tax-free, even when paid to a ‘non-dependant under the tax laws’.
- Taxable component. This component is subject to tax when paid to a ‘non-dependant under the tax laws’. The taxable component can include:
- An element taxed in the fund.
- An element untaxed in the fund: Some long-term public servants will have and untaxed taxable component. The insured component of a benefit may also fall into the untaxed category when the super fund has claimed tax deductions for the insurance premiums.
When your lump sum death benefit is paid to someone other than your death benefits dependant, that is, the benefit is paid to a ‘non-dependant under the tax laws’, the taxable component of the lump sum payment is taxed at 15 per cent (plus Medicare levy) when paid from a super fund. (If a death benefit is paid from certain public sector funds, then a higher rate of tax may be payable.)
For example, if the taxable component of your super benefit is worth $500,000, your financial independent adult child receives $425,000 (less Medicare levy) of this amount and the tax office gets 15 per cent of the benefit —$75,000, plus Medicare levy — when you die.
Where the super death benefit includes an insurance payout, then the insurance payout is taxed at 30 per cent (plus Medicare levy).
Note: If your death benefit is paid to your estate, and then paid to your death benefits dependants or ‘non-dependants under the tax laws’, your benefit is treated the same way as if the benefit were paid directly to these individuals. No Medicare levy, however, is payable on a death benefit paid to your estate.