Most Australians think of superannuation as their retirement savings. But what happens to that money when you die?
One important issue that is often overlooked is superannuation death benefits tax. Depending on who receives your super and how your balance is made up, part of your superannuation could potentially be taxed when it is passed to your beneficiaries.
The starting point is understanding that a super balance is generally divided into two components: tax-free and taxable.
What is the tax-free component?
The tax-free component generally comes from amounts contributed to super where no tax deduction was claimed, commonly known as non-concessional contributions.
For example, if you contributed $100,000 of your own after-tax savings into super, that amount would generally form part of your tax-free component.
As the name suggests, the tax-free component of a super death benefit is generally received tax free, regardless of whether it is paid to a tax dependant or non-dependant.
What is the taxable component?
For many Australians, most of their super balance will be taxable component.
This is broadly because employer super contributions, salary sacrifice contributions and personal contributions for which a tax deduction was claimed generally enter super on a concessional basis.
Investment earnings generated within the fund can also add to the taxable component over time.
This distinction becomes particularly important when super is eventually paid as a death benefit.
Who receives the money matters
If your super death benefit is paid as a lump sum to a death benefits dependant for tax purposes, it will generally be tax free.
This commonly includes a spouse, a child under 18, someone who was financially dependent on you, or someone with whom you had an interdependency relationship.
The potential problem arises when super is paid to an adult child who is not financially dependent on the deceased.
In that situation, the tax-free component remains tax free, but tax can apply to the taxable component. For the common taxed element of the taxable component, the tax rate is generally up to 15% plus Medicare levy. Untaxed elements can potentially be taxed at a higher rate.
Consider someone with $500,000 in super consisting of:
- $100,000 tax-free component
- $400,000 taxable component
If the benefit passes to an independent adult child, the $100,000 tax-free component remains tax free, while tax may apply to the $400,000 taxable component.
That can translate into tens of thousands of dollars of tax.
Why planning ahead matters
This is why superannuation should be considered as part of your broader estate planning rather than simply treated as another investment account.
In some circumstances, strategies may be available to increase the tax-free component before death. One example is withdrawing money from super and recontributing it as a non-concessional contribution, where the person is eligible to do so. This is often referred to as a recontribution strategy.
However, contribution caps, age rules, total super balance limits and the person’s broader circumstances all need to be considered carefully.
The important takeaway is simple: a super balance of $500,000 does not necessarily mean your adult children will inherit $500,000.
Understanding who will receive your super, and how much of your balance is taxable versus tax free, can make a significant difference to what ultimately reaches your family.