Strategies to Minimise Super Tax on Death

When a superannuation fund member passes away, the treatment of their remaining balance depends heavily on who inherits it. Under current tax law (primarily the Income Tax Assessment Act 1997), certain individuals are considered 'tax dependants'. This typically includes a spouse (including de facto), minor children (under 18), or someone financially dependent on the deceased at the time of death. For these beneficiaries, superannuation death benefits are generally received tax-free, whether as a lump sum or an income stream (if permitted by the fund).

However, independent adult children are not considered tax dependants. When they inherit a superannuation death benefit, the portion of the super balance known as the 'taxable component' is subject to tax. This taxable component generally consists of concessional (before-tax) contributions (like employer contributions and salary sacrifice) and investment earnings accumulated within the fund. For benefits paid from a taxed super fund (the most common type), this component is taxed at 15%, plus the Medicare Levy of 2%, resulting in a total tax rate of 17%. The 'tax-free component' (usually comprising non-concessional, or after-tax, contributions) remains tax-free.

Given this potential tax erosion, exploring strategies to minimise the impact is a vital part of later-life financial planning, particularly for those whose primary beneficiaries are likely to be adult children.

Strategies to Reduce Superannuation Death Tax

Here are four potential approaches, sourced from analysis of ATO guidelines and discussions with estate planning specialists:

1. The Withdrawal and Re-contribution Strategy

This strategy aims to increase the proportion of your superannuation balance held within the tax-free component.

• How it works: If you meet a condition of release (e.g., reaching preservation age and retiring, turning 65, or meeting specific other criteria), you can withdraw funds from your super. You then re-contribute these funds back into your super account as non-concessional (after-tax) contributions. These re-contributed amounts increase the tax-free component of your super balance.
• The Catch: When you withdraw funds, you must withdraw them in proportion to the existing taxable and tax-free components of your account – you can't just withdraw the taxable part. The re-contribution is then subject to the non-concessional contribution caps.
• Caps and Rules (as of 2024/2025 financial year):
  • The standard non-concessional cap is $110,000 per year.
  • If you are under age 75, you might be able to use the 'bring-forward' rule to contribute up to $330,000 in one year (covering three years' worth of caps), provided your Total Super Balance (TSB) was below $1.9 million on the preceding 30th of June.
• Example (Author Calculation): Sophia, aged 67 and retired, has $950,000 in super. $600,000 is the taxable component (~63%) and $350,000 is tax-free (~37%). Her TSB allows her to use the bring-forward rule. She decides to withdraw and re-contribute $330,000.
  • Withdrawal: She withdraws $330,000. This withdrawal consists of approx. $208,000 from the taxable component (63% of $330k) and $122,000 from the tax-free component (37% of $330k).
  • Balance after withdrawal: Taxable: $600k – $208k = $392k. Tax-free: $350k – $122k = $228k. Total: $620k.
  • Re-contribution: She re-contributes the $330,000 as a non-concessional contribution. This full amount adds to the tax-free component.
  • Final Balance: Taxable: $392k. Tax-free: $228k + $330k = $558k. Total: $950k.
  • Outcome: The taxable component has reduced from $600,000 to $392,000, significantly lowering the potential death benefits tax payable by her adult children. Future earnings will still add to the taxable component.
• Considerations: This strategy requires meeting a condition of release and careful management of contribution caps. Professional advice is recommended.

2. Directing Superannuation Benefits to Your Estate

Superannuation does not automatically form part of your deceased estate governed by your Will unless specifically directed.

• How it works: You can make a Binding Death Benefit Nomination (BDBN) instructing your super fund trustee to pay your death benefit to your 'Legal Personal Representative' (LPR) – the executor of your Will. The LPR then distributes the funds according to your Will. Some BDBNs lapse (e.g., after 3 years), while others are non-lapsing. It's crucial to ensure your BDBN is valid and achieves your intent. Without a valid BDBN, the trustee typically has discretion over who receives the benefit (within legislative limits).
• Tax Implications: When the super benefit is paid to the estate, the LPR is responsible for paying the tax on the taxable component (still 15% for a taxed fund). However, once the tax is paid by the estate, the subsequent distribution of the net amount to a beneficiary (like an adult child) is generally not taxed again in their hands.
• Key Advantage: The 2% Medicare Levy is not applied when the tax is paid by the LPR of the estate.
• Example: Consider a super balance of $700,000 with a $400,000 taxable component, intended for an adult child.
  • Paid Directly to Adult Child: Tax = $400,000 * (15% + 2% Medicare Levy) = $400,000 * 17% = $68,000. Net received = $700,000 – $68,000 = $632,000.
  • Paid via Estate: Tax paid by LPR = $400,000 * 15% = $60,000. Medicare Levy saved = $8,000. Net distributed from estate = $700,000 – $60,000 = $640,000.
  • Outcome: Directing the benefit via the estate saves $8,000 in this scenario.
• Other Benefits: Receiving the inheritance via the estate means the super payout amount does not form part of the beneficiary's personal assessable income for that year. This can be beneficial as it won't affect things like their HELP debt repayments, eligibility for certain government benefits (like Family Tax Benefit), or trigger Division 293 tax for high-income earners.

3. Withdrawing Superannuation Prior to Death

This strategy is more direct but relies on timing and meeting eligibility criteria.

• How it works: If you meet a condition of release (like retirement, reaching age 65, or diagnosis of a terminal medical condition), you can choose to withdraw your entire super balance before you pass away. Once withdrawn, the money is no longer within the superannuation system and therefore not subject to superannuation death benefits tax. It becomes cash or other assets held personally.
• Tax on Withdrawal:
  • If you are aged 60 or over, withdrawals from a taxed super fund are generally tax-free.
  • If you are under 60 but have met a condition of release, the taxable component of withdrawals above the 'low-rate cap' (currently $235,000 for the 2024-25 financial year) may be taxed (often at 17%). The tax-free component remains tax-free.
• Considerations: This requires the ability to access super funds. If incapacity occurs before withdrawal, having an Enduring Power of Attorney (EPOA) in place may allow your nominated attorney to make withdrawals on your behalf, subject to the terms of the EPOA and superannuation law. This strategy is often considered when facing a terminal illness with no tax dependants. Once withdrawn, the funds lose the tax advantages of the superannuation environment and become part of your personal assets for estate purposes (and potentially subject to aged care means testing if relevant).

Conclusion

Navigating the tax implications of superannuation death benefits requires careful planning. The strategies outlined offer potential ways to maximise the inheritance received by non-dependant beneficiaries like adult children, but each involves specific rules, potential drawbacks, and interactions with broader estate planning. As individual circumstances vary greatly, seeking personalised financial and legal advice is essential to determine the most effective approach for your situation and ensure your wishes are carried out efficiently.

The information contained in this article is general information only. It is not intended to be a recommendation, offer, advice, or invitation to purchase, sell, or otherwise deal in securities or other investments. Before making any decision regarding a financial product, you should seek advice from an appropriately qualified professional. We believe that the information contained in this document is accurate. However, we are not specifically licensed to provide tax or legal advice and any information that may relate to you should be confirmed with your tax or legal adviser.