How your super will be taxed when you die
The ins-and-outs of super taxation on death benefits.
We are in the opening stages of the largest intergenerational wealth transfer in history. An estimated $3.5 trillion of assets in Australia will be passed on prior to 2050. As it stands now, 21% of household wealth is held in superannuation. As contributions continue to rise superannuation will continue to be a significant stake of household wealth.
When this transfer of superannuation takes place, how much will go to your next of kin?
Like all answers with your finances – it depends.
There are a few factors that will influence the size of the inheritance received from assets within the super system:
- Whether it is a lump sum benefit or an income stream
- It can only go to a dependant, there are two definitions – super and tax dependants. Whether the recipient is defined as a tax or super dependant will determine tax paid
- The tax designation of the super assets (i.e., taxable taxed/untaxed and tax-free components) – the components in each designation are available through annual statements, or by contacting the superannuation fund
- The age of the deceased and the age of the beneficiary
Dependants matter
There are conflicting definitions of what a dependant is when it comes to superannuation and tax law.
Superannuation is governed by the SIS Act. It defines a dependence as ‘dependant, in relation to a person, includes the spouse of the person, any child of the person and any person with whom the person has an interdependency relationship.’
This means that a valid dependant can be a spouse (not former), a child, or any person that has an interdependent relationship.
A tax dependant in relation to death benefits is a little different.
s302-195 (1): A death benefits dependant, of a person who has died, is (a) the deceased person’s spouse or former spouse; or (b) the deceased person’s child, aged less than 18, or (c) any other person with whom the deceased person had an interdependency relationship under section 302-200 just before he or she died, or (d) any other person who was a dependant of the deceased person just before he or she died.
This means that a spouse or former spouse, any children under 18, and any financial dependants would be eligible for preferential tax treatment.
In short, any adult children would not be categorised as a tax dependant and would face different tax treatment.
How a superannuation lump sum will be taxed
How a superannuation income stream will be taxed
When it comes to income streams from a pension account, reversionary beneficiaries can be nominated. A reversionary beneficiary means that upon the owner’s death, the pension will continue seamlessly to an eligible dependant (as discussed above).
However, there are some limits. According to the ATO, “Children can only receive an income stream if they are under 18, or under 25 and are financially dependent on the deceased or have a permanent disability. Adult children with a permanent disability can continue to receive an income stream after they turn 25 years old. In all other situations, the income stream must change to a lump sum on or before the date they turn 25 years old.
The different types of beneficiaries and how to nominate them
Retail or industry superfunds will have a Nomination of Beneficiaries form. This allows you to nominate your wishes, but there are a few different types.
There are two main types of nominations for superannuation – binding and non-binding.
Binding nominations are a legally valid nomination to a valid dependant. Binding nominations can be lapsing, or non-lapsing. Non-lapsing is valid until death, but lapsing is the most common, and means that it expires every three years, and this is done because there’s room for circumstances to change.
For example, you might make a nomination for a spouse. Twenty years later you might have children, you might be remarried, you might be divorced – there’s a range of possibilities over the decades that you have super. A lapsing nomination expires to account for that. Once it does lapse, if it’s not renewed it turns into a non-binding nomination. This is a strong suggestion as to where a death benefit should be paid. The trustees of the superannuation fund will take current circumstances into account.
Then, there’s reversionary beneficiaries. Distribution of estates can be a messy, complicated and a drawn-out drawn affair. Reversionary beneficiaries are important if there is a loved one that is financially dependent (or interdependent) on the income stream coming from a pension account. Upon death, a reversionary beneficiary will receive the income stream payments without delay. This is instead of the decision going to the superannuation trustees and requiring more paperwork (and time).
