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Taxation of super benefits

Taxation of super death benefits

Section: 7.3

The tax-free component of any death benefit payment is tax-free. The tax treatment of any taxable component depends on whether the recipient is a (tax) death benefits dependant and whether the taxable component consists of a taxed element or untaxed element.

Recipient Tax treatment of taxable component (taxed element) Tax treatment of taxable component (untaxed element)
Death benefits dependant Non-assessable non-exempt income: No tax Non-assessable non-exempt income: No tax
Non-death benefits dependant Assessable income: Maximum tax rate of 15% Assessable income: Maximum tax rate of 30%

Note: For all non-zero tax rates, Medicare levy may also apply.

Who is a (tax) death benefits dependant?

A death benefits dependant for tax purposes is:

  • the deceased person's spouse or former spouse, or
  • the deceased person's child, aged less than 18, or
  • any other person with whom the deceased person had an interdependency relationship just before he or she died, or
  • any other person who was a dependant of the deceased person just before he or she died, or
  • an individual who receives a superannuation lump sum because of the death of another person if the deceased person died in the line of duty as; a member of the Defence Force, Australian Federal Police, police force of a State or Territory; or a protective service officer.

No low rate cap for death benefits

The low rate cap is not applicable to super death benefits. If there is a taxable component paid to a non-dependant, the entire component is taxed.

Lump sum death benefits paid to a deceased client's estate

Where a death benefit is paid to a legal personal representative as executor of an estate, no tax is withheld by the trustee of the super fund. The tax treatment when received by the estate is as follows:

  • To the extent that death benefits dependants will (or could be expected to) benefit from the death benefit, it is non-assessable non-exempt income of the estate and not taxed.
  • To the extent that non-death benefit dependent beneficiaries will (or could be expected to) benefit from the death benefit, it is subject to the same taxation in the estate as a non-death benefit dependant would pay had they received the benefit directly. However, Medicare levy does not apply.

Superannuation death benefits paid to a deceased client's estate which are then distributed to beneficiaries are not assessable in the hands of the beneficiaries.

Untaxed element for certain death benefit lump sums

A lump sum super death benefit that is sourced wholly or partly from insurance proceeds may include an untaxed element, even if the fund itself is subject to tax on contributions and earnings. If the fund claims a tax deduction either for life insurance premiums paid or for a future liability to pay benefits, then the taxable component of the death benefit includes an untaxed element.

Where the lump sum super death benefit is paid to a dependant, the inclusion of an untaxed element is irrelevant, as no tax will be payable on the benefit. However, where a non-dependant receives a death benefit that includes an untaxed element, a higher rate of tax applies to that part of the benefit.

Calculating the untaxed element

Untaxed element = taxable component - taxed element

where:

  • Taxed element = (amount of lump sum super death benefit x service days /(service days + days to Retirement)) - tax-free component
  • days to retirement is the number of days between the date of death and the deceased's last retirement date (generally age 65), and
  • service days is the number of days from the day the member joined the fund or, if a rollover amount was received by the fund with an earlier service period start date, that earlier start date to the date of death. For an employer sponsored fund, service days may commence when the member's employment commenced, if that was prior to the commencement of their fund membership.

If the calculated result is negative (ie where the tax-free component is large in relation to the total benefit), the taxed element in the fund is nil and the whole of the taxable component is an untaxed element.

Minimising the untaxed element

Because of the way that the untaxed element calculation operates, there are a number of ways that it can be minimised, depending on a client's situation.

Maximising a client's service period

The longer the existing service period of a client's superannuation interest, the less untaxed element their lump sum death benefit will contain.

The existing service period of a client's superannuation interest generally commences on the earlier of the date they joined the fund, or the date they commenced employment with an employer who has contributed to the fund. However, where a client has rolled money into the fund that has a longer existing service period, the start date of that service period must be used instead.

Clients can therefore rollover super benefits with a longer existing service period to minimise their untaxed element.

Example

David is aged 53. He set up a SMSF two years ago and is making both concessional and non-concessional contributions. He recently took out life cover of $1 million through his fund. In the event of his death, his super benefit will be paid to his adult daughter, Beth. David also has a small industry super fund worth $500 which he set up 20 years ago, which he is considering consolidating into his SMSF. Let's look at how this rollover will impact on the untaxed element of his lump sum death benefit, assuming he dies in two years, with an existing SMSF balance of $200,000 (50% tax-free).

  No rollover Rollover
Service period (assuming 365 days per year) Service days: 1,460

Days to retirement: 3,650

Service days: 8,030

Days to retirement: 3,650

Tax-free component $100,000 $100,000
Taxable component (taxed element) $242,857 $725,000
Taxable component (untaxed element) $857,143 $375,000
Total lump sum death benefit1 $1.2 million $1.2 million
Tax and Medicare levy $315,571 $243,250
Net death benefit $884,429 $956,750

1 $500 rollover balance ignored due to small value.

We can see that Beth would receive a net death benefit that is $72,321 more as a result of David having rolled over his industry fund balance to his SMSF.

Impact on disability super benefit tax-free component

It is important to note that where a client holds life and TPD cover through super, the above strategy of maximising a client's existing service period will reduce the 'tax-free uplift' calculation that applies to a lump sum disability super benefit they receive. For further information about the taxation of disability super benefits.

Keeping large after tax contributions separate

Under the untaxed element calculation, a client who adds large amounts of tax-free component to the superannuation interest that holds their insurance will in most cases convert an amount of what would have otherwise been a taxed element to an untaxed element. Clients considering making large non-concessional contributions should therefore consider making these to a separate superannuation interest from the interest holding their life insurance.

Example

Sharon is aged 50 and has a current super balance of $100,000 (50% tax-free component) in a fund she set up 10 years ago. She has life insurance of $1 million within the fund. In the event of her death, her super benefit will be paid to her adult daughter, Emily.

Sharon now wants to make a non-concessional contribution of $300,000 using the 'bring-forward rule'. Assuming she passed away immediately after her contribution, let's compare the impact on her untaxed element of either making the non-concessional contribution to her existing super interest or to a separate superannuation interest.

Existing super interest Contribute to same interest Contribute to new interest
Service period (assuming 365 days per year) Service days: 3,650

Days to retirement: 5,475

Service days: 3,650

Days to retirement: 5,475

Tax-free component $350,000 $50,000
Taxable component (taxed element) $210,000 $390,000
Taxable component (untaxed element) $840,000 $660,000
Total lump sum death benefit $1.4 million $1.1 million
Tax and Medicare levy $304,500 $277,500
Net death benefit $1,095,500 $822,500
Total death benefits Contribute to same interest Contribute to new interest
Net death benefit existing super interest $1,095,500 $822,500
Net death benefit new super interest (all tax-free component) Nil $300,000
Total net death benefit $1,095,500 $1,122,500

By ensuring that her $300,000 non-concessional contribution is made to a new super interest, Sharon has allowed Emily to receive a $27,000 higher overall death benefit.

Last modified: Friday, January 12, 2018