Super and estate planning
Taxation of superannuation lump sum death benefits
The tax-free component of any lump sum 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||Taxable component (taxed element)||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, except where paid to the deceased member's estate.
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, age 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 member'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 member'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
If the calculated result is negative (ie where the tax-free component is large in relation to the total benefit), the taxed 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 member's situation.
Maximising a member's service period
The longer the existing service period of a member's superannuation interest, the less untaxed element their lump sum death benefit will contain.
The existing service period of a member'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 member has rolled money into the fund that has a longer existing service period, the start date of that service period must be used instead.
Members can therefore roll over super benefits with a longer existing service period to minimise their untaxed element.
David is age 53. He set up an 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 that 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).
^ $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 member holds life and TPD cover through super, the above strategy of maximising a member's existing service period will reduce the 'tax-free uplift' calculation that applies to a lump sum disability super benefit they receive.
Keeping large after tax contributions separate
Under the untaxed element calculation, a member 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. Members considering making large non-concessional contributions should therefore consider making these to a separate superannuation interest from the interest holding their life insurance.
Sharon is age 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.
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: Wednesday, July 24, 2019