If you plan to leave your super to your adult children when you die, your superannuation 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 superannuation 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” (under the Income Tax Assessment Act 1997). Death benefits dependants (that is, dependants under the tax laws) include your spouse, children under the age of 18, any individuals who are financially dependent upon you (which can include adult children), or any individuals who have an interdependency relationship with you (which can also include adult children). A child who is permanently disabled is considered a death benefits dependant even when over the age of 18.
Now, the rules can be confusing because a financially independent adult child is considered a dependant under the super laws, 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 interdependency 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: The super laws (section 10A of the SIS Act) define an ‘interdependency relationship’ to be 2 persons (whether or not related by family), if they have a close personal relationship, and they live together, and one of each of them provides the other with financial support, and one or each of them provides the other with domestic support and personal care. An interdependency relationship (whether or not related by family) can also be 2 persons who have a close personal relationship but due to either or both persons suffering from a physical, intellectual or psychiatric disability, they don’t live together, and they don’t provide financial support, and they don’t provide the other with domestic support and personal care.
Important: 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 an untaxed taxable component. The insured component of a superannuation death benefit may also fall into the untaxed category when the super fund has claimed tax deductions for the insurance premiums. (Insurance payout to a death benefits dependant is free of tax.)
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 2% 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 financially independent adult child receives $415,000 of this amount and the tax office gets 17 per cent of the benefit —$85,000 — when you die.
Where the super death benefit includes an insurance payout, then the insurance payout can be taxed at 32 per cent (30% benefit payments tax plus 2% 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.
New transfer balance cap for pension may cause problems for superannuation death benefits
Since 1 July 2017, the government has imposed a cap on the amount of super that can be transferred into pension phase (see SuperGuide articles Retirement phase: A super guide to the $1.6 million transfer balance cap and Superannuation death benefits and the $1.6 million transfer balance cap). The government has also abolished the anti-detriment payment rules (see SuperGuide article Anti-detriment payments banned since July 2017).
Important: If you are part of a couple, and the combined super benefits of your spouse and yourself are likely to exceed $1.6 million when one of you pass away, then note that any benefits either of you receive a death benefit, will count towards the surviving spouse’s individual transfer balance cap, and a death benefit lump sum may not be able to be retained in the super system due to the transfer balance cap rules.. Note that this scenario could also arise with any dependant eligible to receive a superannuation death benefit. For more information, see SuperGuide article Superannuation death benefits and the $1.6 million transfer balance cap.