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Nobody enjoys paying more tax than necessary. Even when you die the tax office will be quick to take a cut of your super death benefit if you aren’t careful.
So, to avoid having your beneficiaries pay more tax than necessary, it’s important to become familiar with the tax rules governing super death benefits.
That way you can plan the distribution of the assets in your estate – including your super – with these rules in mind, ensuring your benefits are paid in the most tax-effective manner possible.
Receiving a super death benefit: Dependant or not?
When a super death benefit is paid out, tax payable depends on whether the recipient is categorised as a dependant or non-dependant according to the Income Tax Assessment Act 1997 (tax law).
Note the definition of dependant in tax law is different from the definition in super law that governs who can be paid a death benefit directly from a super fund.
Your dependants for tax purposes are:
- Your spouse or de facto spouse (of any sex)
- Your former spouse or de facto spouse (of any sex)
- Your children aged under 18
- Someone with whom you had an interdependency relationship
- Someone who was financially dependent on you (known as an ‘ordinary meaning’ dependant).
Any person receiving a death benefit because the deceased died in the line of duty as a member of the defence force, Australian Federal Police or a state police force, or as a protective services officer is also a death benefit dependant under tax law.
You are in an interdependency relationship if you and the other person live together, have a close personal relationship and at least one of you provides the other with financial support, domestic support and personal care. For more details on interdependency relationships, see the ATO website here.
Defining financial dependency for tax purposes
The ATO can take a much stricter approach to defining an ordinary meaning dependant under tax law than super funds use when defining a SIS dependant.
Although your super fund may decide to pay a person your death benefit on the basis they were financially dependent on you, the ATO may not assess them as a dependant for tax purposes.
The ATO expects ordinary meaning dependants to be fully or substantially financially dependent on the deceased to receive a favourable tax treatment on a death benefit payment. To meet this requirement, a person needs to be unable to meet their normal living expenses without the financial support of the other person.
An example of the impact of this stricter definition is a case whereby an elderly woman was paid her son’s death benefit by his super fund on the basis he saved her money by doing odd jobs around her house, which she would otherwise have had to pay a handyman to complete. The super fund paid the mother the son’s death benefit on the basis she was financially dependent on her son.
The ATO, however, considered the money she saved failed to meet the tax law’s definition of financial dependency, so this death benefit was taxed.
Death benefit pensions and the transfer balance cap
The transfer balance cap (TBC) rules also come into play when it comes to super death benefits.
The TBC rules limit the amount of super savings you can transfer into the retirement or pension phase ($1.9 million in 2023–24). Penalties apply if you transfer amounts in excess of your TBC.
Although the TBC is important when it comes to retirement pensions, the TBC limit also applies to super death benefit pensions. This type of income stream is also counted towards your TBC, so if you become entitled to receive a super death benefit pension, you need to ensure it does not push you over your TBC.
If you risk going over your TBC by taking a super death benefit as an income stream, you may need to consider strategies such as taking the death benefit as a lump sum, taking a mix of pension and lump sum, or using a recontribution strategy.
If a child is receiving a death benefit income stream, their transfer balance cap is increased by ‘cap increments’ that depend on the circumstances. You can read more about the rules for child recipients of death benefit income streams on the ATO website.
Super death benefits: How are they taxed?
If you now have your head around who is and isn’t a dependant under tax law, it’s possible to work out how tax is applied when your beneficiaries receive their super death benefit.
The tax rate applying when a super death benefit is paid to a beneficiary is different depending on whether they are a dependant or non-dependant, and whether the benefit is paid from the tax-free component or the taxable component of your super.
Each component of your super death benefit paid to your beneficiary has a different tax rate:
1. Tax on the TAX-FREE component of a super death benefit
As tax has already been paid on this money when it was contributed into your super account, the tax-free component of your super death benefit is generally paid to your beneficiaries without the need to pay any further tax.
If you are receiving a capped defined benefit income stream, different tax rules may apply, as shown in the table below.
If a beneficiary who is not a tax dependant (most commonly an adult child) is likely to receive your super death benefit, taking steps to increase the tax-free component of your benefit can minimise the tax they will pay. Learn more here.
2. Tax on the TAXABLE component of a super death benefit
Your beneficiaries may be required to pay tax on the taxable component of your super death benefit. The amount of tax they will have to pay depends on:
- Whether your super benefit is paid to your nominated beneficiaries as a lump sum or super income stream
- Whether the person receiving the benefit is a dependant under taxation law
- The age of the beneficiary (for some income streams)
- Your age when you die (for some income streams)
- Whether any income stream is a capped defined benefit income stream or an account-based income stream.
The taxable component is divided into taxed and untaxed elements.
Most Australians are in taxed superannuation funds, which usually only contain taxed elements. However, when a death benefit contains insurance proceeds and the fund has claimed a tax deduction for insurance premiums an untaxed element is created. You can find the ATO’s explanation and example here.
You will also have untaxed element if you are a member of one of the less common untaxed super funds.
The table below summarises how the taxable component of a super death benefit is taxed:
Note: If reading on a mobile device, please view the table in landscape mode.
|Type of death benefit||Age of beneficiary||Age of deceased||Tax on taxable component|
|Taxed element||Untaxed element|
|Paid to dependant||Any age||Any age||Tax free||Tax free|
|Paid to non-dependant||Any age||Any age||Taxed at a maximum rate of 15% (plus Medicare levy)||Taxed at a maximum rate of 30% (plus Medicare levy)|
|Account-based income stream|
|Paid to dependant||Any age||60 years or older||Tax free||Taxed at marginal rates with a tax offset of 10%|
|60 years or older||Any age||Tax free||Taxed at marginal rates with a tax offset of 10%|
|Under 60 years||Under 60 years||Taxed at marginal rates with a tax offset of 15%||Taxed at marginal rate|
|Capped defined benefit income stream|
|Paid to dependant||Any age||60 years or older||50% of income from taxed and tax-free amounts above the defined benefit income cap (if any) is taxed at marginal rates. The remainder is tax free||Taxed at marginal rates with a tax offset of 10%*|
|60 years or older||Any age||50% of income from taxed and tax-free amounts above the defined benefit income cap (if any) is taxed at marginal rates. The remainder is tax free||Taxed at marginal rates with a tax offset of 10%*|
|Under 60 years||Under 60 years||Marginal rate with a 15% offset||Taxed at marginal rate|
* Maximum tax offset is $11,875 for the 2023–24 income year. This has the effect that income from untaxed elements above the defined benefit income cap of $118,750 does not attract the offset.
Source: Based on information from the ATO website.
Tax when benefits are directed through the estate
If your super fund pays your death benefit into your estate, then your executor is responsible for deducting the appropriate tax when the amount is distributed to your beneficiaries.
All benefits paid from the estate are taxed as lump sums.
If the ultimate beneficiary is not a dependant according to tax law, directing the benefit via the estate has tax advantages. As the estate is not an individual, no Medicare Levy is payable, so beneficiaries avoid this additional 2% cost. In addition, the benefit is not added to their assessable income, and as a result it does not affect:
- Other entitlements they may be receiving based on their total assessable income (such as family tax benefit)
- The income used to determine whether they are liable for Division 293 tax on superannuation contributions
- Liabilities based on assessable income such as child support.
When the amount is directed to beneficiaries who are tax dependants, a superannuation proceeds trust (SPT) may be beneficial. An SPT is a kind of testamentary trust that can be established in a will. Income generated from the earnings of an SPT and paid to a minor child is taxed at the usual adult marginal rates instead of the higher rates that usually apply to the unearned income of minors.