What Is Death Benefit Tax?
When superannuation is paid to a tax dependant — such as a spouse — it is generally tax-free. However, when it is paid to a non-tax dependant, such as an adult child who is financially independent, tax may apply to the taxable component of the super balance.
For most standard super funds, the taxable component (known as the “taxed element”) is taxed at 15% plus Medicare levy when paid as a lump sum to adult children. In practical terms, this is often approximately 17%.
For example, if a parent leaves $1 million in super to an adult child and the full amount is taxable component, the ATO may receive roughly $170,000.
What About Untaxed Elements?
This is where it becomes more technical.
Some super funds — particularly certain public sector or defined benefit schemes — may include what is called an “untaxed element.” If part of the benefit is classified as an untaxed element, it can be taxed at up to 30% plus Medicare levy when paid to a non-tax dependant.
That means in some cases, the effective tax rate can be around 32%.
While many retail and industry funds primarily consist of taxed elements, it is critical to review your super statement to understand your specific components.
Understanding Taxable vs Tax-Free Components
Every super balance is made up of:
• Taxable component (usually concessional contributions and earnings)
• Tax-free component (usually non-concessional contributions)
Death benefit tax applies only to the taxable component when paid to adult children.
The higher the taxable proportion, the higher the potential tax bill.
Why Most Families Don’t Plan for This
Superannuation does not automatically form part of your estate under your will. It sits within a trust structure and is distributed according to death benefit nominations.
Many families assume everything will simply pass tax-free. Unfortunately, the tax consequences often only become clear after death, when restructuring options are no longer available.
Strategies to Reduce Death Benefit Tax
There are legitimate strategies available to reduce exposure.
A common strategy is a recontribution strategy. This involves withdrawing funds from super (once eligible) and recontributing them as non-concessional contributions, thereby converting taxable components into tax-free components over time.
Other strategies may include:
• Directing benefits to a spouse first
• Equalising balances between partners
• Aligning estate planning structures
• Managing pension strategies prior to death
The key is that this planning must occur during your lifetime.
Protecting Generational Wealth
If your objective is to build and preserve generational wealth, death benefit tax cannot be ignored. For large super balances, the difference between planning and not planning can equate to hundreds of thousands of dollars.
Superannuation is one of the most tax-effective wealth vehicles in Australia during your lifetime. Without proper structuring, however, it can become significantly less tax-effective when passed to the next generation.
Disclaimer: This information is general in nature and does not consider your personal objectives, financial situation or needs. You should consider seeking professional advice before making any financial decisions. Past performance is not a reliable indicator of future performance.
