Tax-Free Super Death Benefits: Are You Eligible?

Understanding the tax status of superannuation death benefits can surprise many. Find out if you’re eligible for tax-free super benefits in Australia.

Many people assume there is no tax payable on super benefits received after someone passes away, but that’s not always the case. This common misconception can lead to unexpected tax bills for beneficiaries. It’s crucial to understand the specifics of superannuation tax law.

Whether or not tax is paid on a super death benefit depends on the beneficiary’s relationship with the deceased. Although some beneficiaries receive their money tax-free, others can find themselves paying significant amounts of tax on the funds they receive.

Dependant for Tax Purposes

The key point in understanding who will be required to pay tax on a super death benefit is whether or not the beneficiary is considered a death benefit dependant for tax purposes. This definition is critical for tax planning and can significantly affect the financial outcome for beneficiaries.

A death benefit dependant for tax purposes is limited to the deceased’s spouse, de facto, or former spouse or de facto; their child under age 18; any person with whom they had an interdependency relationship; and any other person financially dependent on them just before their death.

A common trap in this area is nominating financially independent adult children as death benefit beneficiaries, as this is permitted under super law. Under tax law, however, they are not defined as dependants for tax purposes and so are required to pay tax on the taxable component of any death benefit they receive.

Tax on Lump Sum Death Benefits

When it comes to paying a death benefit, your dependants for tax purposes are free to choose whether they want to receive your super death benefit as a lump sum or as an income stream. If a beneficiary decides to take their benefit as a lump sum, the benefit will be free of any tax, provided they are considered a death benefit dependant under tax law.

If they are not considered a death benefit dependant for tax purposes, they must take the benefit as a lump sum. These lump sums are taxed at a maximum rate of 15 per cent plus the Medicare levy on the taxed element (which is super that has already had tax paid on it within the fund).

Beneficiaries not meeting the dependant criteria face a 15% tax, plus the Medicare levy, on taxed elements of the lump sum. In addition, any untaxed elements of the taxable component in the lump sum will be taxed at a maximum rate of 30 per cent plus the Medicare levy.

Death Benefit Income Streams and Tax

Some tax dependants prefer to take their death benefit as an income stream (or pension). Death benefit income streams are tax-free if either the deceased or the beneficiary are aged 60 or older at the time the income stream payments are made. This provision offers a significant tax advantage for older beneficiaries, aligning with retirement planning strategies.

Otherwise, beneficiaries will generally pay some tax on the death benefit income stream until they reach age 60, after which age the payments are tax-free. For beneficiaries under age 60, there is no tax on the tax-free component of the death benefit income stream, but the taxable component is included in their assessable income with a 15 per cent tax offset.

Death Benefits and the Transfer Balance Cap

The transfer balance cap (TBC) rules also come into play when it comes to super death benefits. These rules limit the amount of super savings you can transfer into the retirement or pension phase.

Tax penalties apply if amounts in excess of the beneficiary’s TBC are transferred into the retirement phase as an income stream. The rules governing this area are very complex, so you should always seek professional advice before deciding on a death benefit nomination, as it can make a big difference in how much tax your beneficiaries will pay when they receive their death benefit payment.

Professional guidance can navigate the intricate rules and help ensure the most tax-effective outcome for your superannuation benefits.

If you’re navigating the complexities of superannuation and estate planning, our team is here to assist. We offer a complimentary 30-minute consultation aimed at understanding your needs and exploring how we can assist. Feel free to reach out; we’d love to help you optimise your financial legacy.

This article is intended as an information source only and to provide general information only. The comments, examples, words and extracts from legislation and other sources in this publication do not constitute legal advice, financial or tax advice and should not be relied upon as such. All readers should seek advice from a professional adviser regarding the application of any of the comments in this article to their particular situation.