Getting things in order - part 2

Recently I wrote an article  about how superannuation benefits are handled when a member of a superannuation fund dies. I undertook to write a follow up article that considers the taxation implications of superannuation death benefits.

As many readers will be aware, superannuation is a tax advantaged structure for accumulating retirement savings during one’s working life, and then drawing down on those savings in retirement.

In the main, superannuation benefits paid to a person aged 60 or older are tax free[1] irrespective of whether benefits are drawn as lump sum payments, or paid as a regular income stream – generally paid in the form of an account based pension.

Before delving into the depths of the tax applying to death benefits, let’s just recap on the components of a superannuation benefit.

A superannuation benefit will comprise of one, two, and in some instances, three components:

1. Tax-free component – this primarily comprises non-concessional contributions and may also include contributions made under the small business capital gains concessional cap and downsizer contributions.
2. Taxable component – taxed element – generally includes all other contributions including those made by an employer and personal contributions where a tax deduction has been claimed.
3. Taxable component – untaxed element. A taxable component-untaxed element may arise where a person is a member of certain State or Commonwealth superannuation fund. An untaxed element may also arise where a member of the fund passes away, their benefit included life insurance, and the benefit is being paid to a beneficiary that is not a dependant for income tax purposes. More on this later!  

Investment earnings of a superannuation fund will form part of the member’s taxable component unless the fund is in the pension phase, in which case investment earnings are allocated to the tax-free and taxable components in the same proportion that existed at the time the pension commenced to be paid.

When a member of a superannuation fund dies, the fund is required to pay the member’s benefit as soon as practicable. A superannuation death benefit may be paid as a lump sum or as a pension to eligible beneficiaries or to a deceased member’s legal personal representative – in which case it will form part of their estate.

Even though superannuation benefits withdrawn by a member aged 60 or over who is living, will be tax-free, the same is not necessarily the case for a superannuation death benefit.

The Income Tax Assessment Act 1997 defines a dependant for tax purposes a little differently from the superannuation definition.

A dependant, for tax purposes includes a spouse, children under the age of 18, a person that had an interdependency relationship with the deceased, and any other person that may have been financially dependant on the deceased at the time of death. This may include children of the deceased aged 18 or over.

When a superannuation death benefit is paid to a tax dependant as a lump sum, the benefit is paid tax free irrespective of the components that make up the lump sum benefit.

In cases where a death benefit is paid to the estate of a deceased member, a “look-through” occurs. If the eventual beneficiary of the superannuation benefit paid via the estate is a tax dependant, the benefit will also be tax free.

However, if a death benefit is paid to a non-tax dependant, including an adult child not otherwise financially dependent, any portion of the lump sum benefit that comprises of a taxable component – taxed element or taxable component – untaxed element will be subject to tax. Lump sum death benefits are taxed as follows:

Where a death benefit is paid directly by the super fund to a beneficiary, the 2% Medicare Levy is also payable.

To put this in context, if a superannuation death benefit includes the proceeds of a life insurance policy held through super and the death benefit is being paid to a non-tax dependant, say to an adult child, a taxable component – untaxed element will arise. Therefore, the death benefit may be partially tax free (if the deceased had a tax-free component) and the balance will be taxed at 15% and 30% depending on the spilt between the taxed element and the untaxed element.

As mentioned in my previous article, a superannuation death benefit may be paid to an eligible beneficiary as a pension rather than as a lump sum.

When either the deceased or the beneficiary receiving the pension is aged 60 or older, their pension income will be tax free, irrespective of the underlying components that make up the superannuation account.

However, where the deceased and the beneficiary are both under 60 years of age, at least a part of the pension income they receive will be included as assessable income and taxed at their marginal tax rate.

The taxation of a death benefit pension, where both the deceased and the beneficiary are under 60 is taxed as follows:

Dealing with superannuation death benefits can be very complex and each person’s situation will often be different. Ensuring that superannuation benefits are paid to the right people, at the right time, and in the most tax efficient manner is the secret to good estate planning. Working with a qualified financial planner is essential to ensure your benefits will be death with according to your wishes.

[1] This article refers to benefits paid from a taxed superannuation scheme. Superannuation benefits that include an untaxed element (generally paid from some State and Commonwealth public sector superannuation schemes) may continue to be taxable beyond age 60.