The super ‘death tax’ you need to be aware of

Written and accurate as at: 13 December 2022

You’ve worked hard all your life to build up your super, and one day, you will reap the benefits.

But if you pass away sooner than you expected, the remainder of your super will be paid out as a death benefit to your nominated beneficiaries if you have them, or your estate.

And, if your beneficiaries are adult children who are not considered ‘tax dependants’, they could be facing a tax bill that is anywhere up to 32%.

How the super death tax works

When before-tax contributions go into your super account, those contributions are generally taxed at a concessional rate of just 15%. One of the main purposes of super is to help support you in retirement, which is why these contributions are not taxed at your individual income tax rate, and your investment earnings are concessionally taxed as well.  

Another purpose of super, is to pay out the remainder of your super death benefits when you pass away. If your super death benefit is paid out to a tax dependant, it is received entirely tax-free. A tax dependant includes:

  • Your spouse, married or de-facto, whether the same or opposite sex
  • Your children (including step-children) under age 18
  • A financial dependent
  • A person in an interdependent relationship with you.

However, if a non-tax dependant receives your super death benefit as a lump sum, any tax-free component remains tax-free, but the taxable component (taxed element) is taxed at 17% (including a Medicare Levy). And, any taxable component (untaxed element) is taxed at 32% (including a Medicare Levy).

The tax-free component generally consists of non-concessional contributions that you have already paid tax on, therefore no additional tax will apply here. Whereas, the taxable component (taxed element) is usually the remaining balance, consisting of concessional contributions (such as employer contributions, salary sacrifice contributions and personal deductible contributions) and investment earnings. 

Less common is the taxable component (untaxed element), which generally arises where your super fund has not paid any tax on contributions, or where the death benefit includes a life insurance benefit for which the fund has claimed the insurance premiums as a tax deduction.

Strategies to minimise tax on your super death benefit

When it comes to your super, it’s important to be mindful of where the remainder of your super is going to go when you pass away. If your super death benefit is likely to go to a non-tax dependant (such as an adult child), one option you have is to withdraw some of your super and gift it.

After age 60, any withdrawals you make from super are generally tax-free. And, because the super money you withdraw is initially going to you, it generally won’t trigger any tax. What you do with your money after this point is up to you.

Bear in mind that gifting a large portion of your super now could impact your ability to appropriately support yourself later on, and also impact your potential Age Pension entitlements under the gifting and deprivation rules. 

And, if you decide to withdraw the money and hold on to it while you’re still alive (instead of gifting it), will you need to consider investing it elsewhere to help it grow and keep pace with inflation? Also, the money you earn on those investments will not be taxed the same as they would be if held inside of super, so you may end up paying more tax on your earnings.

Another option is to consider a re-contribution strategy. A re-contribution strategy generally involves the withdrawal of a portion of your super benefits as a lump sum and then re-contributing the withdrawn amount back into super as a non-concessional contribution. Doing this can help increase the tax-free component of your super, and subsequently lower any potential tax liability faced by a non-tax dependant beneficiary.

If you are over 65 and retired, you may have discounted this option due to not meeting the ‘work test’. However, from 1 July 2022, if you are under age 75, you may be able to make non-concessional contributions to super, even if permanently retired. And, potentially, also be eligible to bring forward up to the next two years of non-concessional caps, and subsequently ‘re-contribute’ up to $330,000 as non-concessional contributions.

There are a few important things to note with a re-contribution strategy:

  • Super withdrawals you make before age 60 may be subject to tax.
  • You need to meet a condition of release before you can make a lump sum withdrawal from super, and be under age 75 and therefore eligible to make non-concessional contributions.
  • If you’re withdrawing from a taxed super fund, the withdrawn amount must come proportionately from the tax-free and taxable component (taxed element). Let’s say your super benefits comprise of a 10% tax-free component and a 90% taxable component (taxed element). In that case, the withdrawn amount must have this same composition.
  • There are limits on the amount of non-concessional contribution you can make without any penalty. 

The importance of getting advice

Tax on super is complex, and as we’ve discussed, the tax treatment can vary depending on your circumstances, and the circumstances of those who will receive your death benefit. Before you make any decisions, please get in touch with us.