For many Australians, superannuation is close to overtaking the family home as the main asset in estates.

For dependants of a deceased person, like a surviving spouse, the tax situation is as simple as it can be.  You do not pay tax on any component of a superannuation death benefit if you receive it as a lump sum.

In some cases where there is an untaxed element, a 32% tax bill may be payable at a time when we are still grieving the loss of our loved one.

However, it is becoming increasingly common for larger superannuation death benefits to be paid to non-dependants, usually the adult children of the deceased. In this situation the amount of tax payable will depend on the individual components of the lump sum payment.

For the tax-free element, no tax is payable. With regards to the taxable element, this will be taxed at the lower of the beneficiary’s marginal tax rate or 15% for the taxed component or 30% for the untaxed component. The 2% Medicare levy will also need to be paid.

This can be an unwelcome surprise for beneficiaries, but there are solutions.

Here is a simple example

Eric is 63 and has $1 million in superannuation, of which all is in the taxable (taxed) component. If Eric suffers from a condition which he is aware is terminal, he could withdraw the full $1 million, prior to his passing, and as he is over 60, the entire amount would be tax-free. In this situation, no tax would be payable even when it is passed to his adult children.

If he were to die suddenly, the benefit would be paid to his adult children and $170,000 would be lost in tax (15% plus 2% Medicare levy).

Plan for a solution

 As with most things in life, prior planning can help. People aged between 60 and 65 can make tax-free lump sum withdrawals from superannuation and return them as non-concessional contributions. The funds then become a part of the tax-free component. If a work test is satisfied, over-65s can also use this strategy. Due to the limits on non-concessional contributions, this is a strategy that needs to be implemented earlier rather than later, particularly where large sums of money are involved.  You must seek advice from your financial adviser before implementing this strategy.

People who can no longer contribute to superannuation and have large taxable components face a dilemma. The tax-free environment of a superannuation pension is too valuable to ignore, but any subsequent death benefit may come with a significant tax liability. On the other hand, cashing out and investing outside superannuation may create an ongoing income tax liability. Over the long term, this could lead to a larger tax bill.

Another issue recipients of death benefits might face relates to the transfer balance cap of $1.6 million which limits the amount you can have in a pension in super.  Let’s say you are already receiving a superannuation pension and you then receive a pension from your deceased spouse, if the combined balance of the 2 pensions is more than $1.6million then you need to take action.  Individuals who breach the cap will be subject to additional tax, similar to the tax treatment that applies to excess non-concessional contributions.

Of course, everyone’s situation and circumstances will be different, so to ensure your beneficiaries are not faced with any nasty super surprises after you have gone, talk to us about putting a plan in place.

Contact one of our WGC Lawyers Wills & Estates Team today.