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When you die, the tax man can be pretty quick to put his hand out to take his cut, and this also applies to the balance of your super account.
But working out just how much of your super death benefit will be paid to your nominated beneficiaries and how much will go to the ATO isn’t straightforward.
To work out the tax rate that will apply, you first need to know who is and isn’t a dependant under both superannuation and taxation law.
Did you know?
When the balance of your super account is paid out to your beneficiaries following your death, it’s called a super death benefit.
For more about nominated beneficiaries, see SuperGuide article Who gets your super when you die? A guide to death benefit nominations.
Receiving a super death benefit: Dependant or not?
Your super fund can pay out a super death benefit to two different categories of beneficiaries when you die:
- Your dependants – To make things nice and complex, there are two definitions for the dependant of a super fund member. One relates to who is entitled to receive a super death benefit payment (superannuation law) and the other one is for how the super death benefit will be taxed (taxation law).
Dependants can choose whether to receive a super death benefit as a lump sum or an income stream.
- A non-dependant – If you do not meet the definition of a dependant of the deceased super member and are their nominated beneficiary, you are considered a non-dependant.
The amount of tax to be paid on the death benefit will depend on how much of it is a tax-free component and how much is a taxable component (taxed and untaxed elements).
From 1 July 2007, non-dependants can only receive a super death benefit as a lump sum.
For more information about the tax-free and taxable components of a super account, see SuperGuide article Proportioning rule and super tax: What it is and why it matters.
Who is a dependant under superannuation law?
When it comes to receiving a super death benefit, superannuation law considers you to be a dependant of the deceased super fund member if at the time of their death you were:
- their spouse or de facto spouse
- one of the member’s children (any age)
- in an interdependency relationship with the person.
Note
Under super law, you are considered to be in an interdependency relationship if you and the other person live together, have a close personal relationship, and one of you provides the other with financial support and domestic support and personal care.
Who is a dependant under taxation law?
The definition of a dependant is different under taxation law and this is important when it comes to working out how much tax beneficiaries will need to be paid on any death benefit they receive
You are considered a tax dependant of a deceased super fund member if at the time of their death you were:
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- their spouse or de facto spouse (of any sex)
- their former spouse or de facto spouse (of any sex)
- one of their children aged under 18
- in an interdependency relationship with them
- any other person dependant on the deceased.
FYI: Under taxation law, the definition of an interdependency relation is similar to the one under super law, but the definition can be wider in disability cases. Children aged over 18 must have been financially dependent to be considered a dependant. For more information, see the ATO website here.
Super tip
Under tax law, adult children are only allowed to receive an income stream from a super death benefit if they are aged under 25 and were financially dependent on the deceased super fund member or have a permanent disability. Adult children with a permanent disability can continue to receive an income stream after they reach age 25.
Once an adult child without a permanent disability reaches age 25, their income stream must be converted into a lump sum.
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 ($1.6 million in 2019/2020) of super savings that can be transferred into the retirement or pension phase, with penalties applying for any amounts transferred in excess of the TBC.
In addition to retirement pensions, the TBC rules also apply to super death benefit pensions. This means these income streams also count towards your TBC, so if you become entitled to receive a super death benefit pension, you need to take care that it does not cause you to exceed your TBC.
If you risk going over your TBC by taking a super death benefit as a pension, 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. The rules governing this area are very complex, so you should always seek professional advice before taking any action.
For more information on the TBC, see SuperGuide article Definitive guide to the $1.6 million transfer balance cap.
Super death benefits: How are they taxed?
If you now have your head around who is and isn’t a dependant under both super and 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 it relates to is the tax-free component or the taxable component (taxed and untaxed elements) of the benefit:
1. Tax on the TAX-FREE component of a super death benefit
As tax has already been paid on it 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.
Your beneficiaries will not pay tax on the tax-free component of a super death benefit whether it is withdrawn as a lump sum or received as an account-based income stream.
2. Tax on the TAXABLE component of a super death benefit
Although the tax-free component of a super death benefit does not incur tax, your beneficiaries may be required to pay tax on the taxable component of your super death benefit. The amount of paid 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 the income stream is a capped defined benefit income stream or an account based income stream.
The table below provides a summary of how the taxable component of a super death benefit is taxed in different situations.
* Remember: Super death benefits can no longer be paid as an income stream to a non-dependant.
| Type of death benefit | Age of beneficiary | Age of deceased | Tax on taxable component | |
|---|---|---|---|---|
| Taxed element | Untaxed element | |||
| Lump sum | ||||
| 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 | 60 years or older | 60 years or older | 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 | |
Source: Based on information from the ATO website.
Case study 1: Superannuation death benefit paid to dependant
Leon was a member of a large industry super fund for many years and he nominated his wife Josie as the beneficiary for his super death benefit of $175,000.
When he died unexpectedly at age 63, Josie applied to the super fund to receive Leon’s super death benefit as a lump sum payment.
As Josie was Leon’s surviving spouse, she was classified as a dependant and received his full super death benefit of $175,000 tax-free.
Case study 2: Taxed and tax-free components of super death benefit paid as income stream
Wendy was receiving an account-based super income stream (which had a balance of $250,000), from her super fund when she passed away at age 67.
The tax-free proportion of her $250,000 income stream is 25%, with the remaining 75% being the taxable proportion.
Wendy’s spouse Raffa is her beneficiary and he decides to take her account balance as a lump sum. Raffa is paid the lump sum in the same proportions of tax-free and taxable components as Wendy’s income stream.
This means Raffa’s tax-free and taxable components from the lump sum death benefit are:
Tax-free component = $250,000 x 25% = $62,500
Taxable component = $250,000 – $62,500 = $187,500
Raffa is considered Wendy’s dependant under tax law, so he receives the entire lump sum tax-free.
If Raffa was considered a non-dependant under tax law, the taxable component of his lump sum would be subject to tax, with different rates applying to the taxed and untaxed elements (see table above).
For more information about the tax-free and taxable components of a super account, see SuperGuide article Proportioning rule and super tax: What it is and why it matters.
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Thank you very informative.