Strategies to Limit Tax on Lump Sum Super Death Benefits

Super death benefits are potentially taxable depending on who receives them and the components of the super payment. Generally, superannuation has two components, a tax-free component and a taxable component. The components can usually be found on the member's statements.
The tax-free component is tax free, regardless of who receives the benefit. However, the taxable component may be taxed as follows:
1. If paid to a ‘death benefit dependant’ both components are tax free. An eligible death benefit dependant is one of the following:

(a) Spouse, whether married or de facto

(b) A former spouse

(c) A child under 18 years

(d) A child over 18 years, who was actually dependant on the deceased member at the time of death

(e) Any other person who is actually dependant on the deceased member at the time of death.

2. If the death benefit is received by someone who is not a ‘death benefit dependant’, the taxable component is taxed at 15% plus Medicare levy of 2%. If the death benefit is paid to the Legal Personal Representative (Executor) and distributed to a person who is not a ‘death benefit dependant’ the estate pays a tax of 15% but no medicate levy. If a death benefit includes a life insurance benefit, then the life insurance component can be taxed at 30%.

Example of taxation of superannuation death benefits

Tom (aged 64 years) is a retired widower who has two adult children, Ted and Tess. Ted is married with children, and Tess is single and dependent on Tom (that is, she still lives at home with Tom and relies on him for financial support). Tom has a binding death benefit nomination (BDBN) in place dividing any super death benefit equally between Ted and Tess. Tom’s Will leave all assets equally to Ted and Tess. Tom dies leaving a death benefit of $1 million made up as follows:

- $500,000 tax free component

- $500,000 taxable component

As Tess qualifies as a ‘death benefit dependant’, she receives $500,000 tax free. However, as Ted is not a death benefit dependant, he receives $457,500 after paying tax of $42,500 ($250,000 * 17%).

Could Tom have taken steps to minimise the tax consequences of his death? Yes, as set out below:

1. As Tom is over 60 years old and retired, he could have withdrawn his super prior to his death, and the withdrawal would be tax free. The super proceeds would then form an asset of his estate and passed tax free to Ted and Tess

2. Tom should have in place an Enduring Power of Attorney (EPA) appointing Ted and Tess as financial attorneys. If Tom was incapacitated, Ted and Tess could use the EPA to withdraw the funds prior to Tom’s death. The funds would be received on behalf of Tom and would be tax free.

3. Assuming that there was no opportunity to withdraw the super before Tom’s death, the tax could have been minimised by Tom opting to pay the super death benefit to his Executor, so it passed to Ted and Tess via Tom’s estate. That would reduce the tax on the taxable component from 17% to 15%, a saving of $5,000. 

4. He could have left the whole of his superannuation to Tess who would not pay any tax. In his Will, he could have then ensured that he equalised this unequal distribution to Tess by bequeathing an additional $500,000 to Ted. This of course would only be possible if Tom’s estate was significant enough to allow this adjustment and it would potentially leave Tess with an ability to contest the unequal distribution of Tom’s estate. That risk could of course have been mitigated by full communication to Ted and Tess of Tom’s overall intentions.

Importance of proper estate planning

There are a number of important estate planning considerations raised by the example, including:

  • the importance of ensuring you have in place an EPA; and
  • ensuring you also put in place a suitable BDBN; and
  • notifying your intended beneficiaries and/or attorneys of the steps they may need to take in respect of superannuation to minimise the taxation impacts; and
  • more generally, ensuring you obtain accounting advice so that you can take steps to minimise the taxation treatment of the taxable component of super death benefits in the hands of your beneficiaries.

Enduring powers of attorney [1]  

In Queensland, an EPA allows the person making it (the principal) to appoint someone he/she trusts (an attorney or attorneys) to make decisions during the principal’s lifetime. With an EPA, the power you give your attorney will continue when you lose capacity to make decisions about those matters for yourself and will end on death. [2]

Under an EPA, a principal can authorise their attorney to make decisions about:

  • personal (including health) matters such as health care, support services, and where you live.
  • financial matters such as paying expenses, making investments, selling assets and as in the example above, withdrawing superannuation prior to death.

 A principal can decide when an attorney’s power to make decisions about financial matters begins but the power of attorney for personal/health matters will only begin when you lose capacity yourself to make those decisions. You can only make an enduring power of attorney when you have capacity so it is too late to do this after the fact.

An EPA will give your attorney(s) full control over the exercise of the power over financial and personal/health matters (subject to any limits you specify in the power of attorney document). Accordingly, it is important to choose your attorney(s) carefully. Whilst there is legislation in place in each State that requires attorneys to act properly, the ‘horse has already bolted’ once an attorney mismanages their role so avoidance is the key. One tool to ensure no impropriety is to appoint more than one attorney and require that they make decisions jointly/unanimously.

You should ensure that you notify your attorneys of their appointment and let them know your wishes and preferences. This can actually be included in the power of attorney form in Queensland. The above example illustrates the importance of ensuring your attorneys (who are usually also intended beneficiaries of super death benefits) know what steps they may need to take.

With a self managed superannuation fund (SMSF), ensuring you have a power of attorney in place is also key to ensuring that your SMSF can continue to operate and remain compliant. [3]

Binding death benefit nominations

Without a BDBN, the trustee of a SMSF or industry superannuation fund has complete discretion as to who receives the death benefit between your dependants and legal personal representatives and in what proportion. Having a BDBN nomination in place ensures certainty as to how your death benefit is distributed, and, as illustrated by the above example, may also ensure less taxation impacts to your intended beneficiaries.

A BDBN can also be useful as an estate planning tool to ensure that the superannuation death benefit does not form part of your estate and in the process, avoid any delays associated with estate administration and avoid any risk of a possible family provision applications impacting the superannuation.

In making a BDBN, it is important to ensure that:

(a) you only leave your benefits to a death benefit dependent (as explained above).

(b) you ensure it remains current and does not lapse.

(c) you ensure it complies with all the formalities of regulation 6.17A of the Superannuation Industry (Supervision) Regulations 1994 (in writing, two witnesses etc).

As the above demonstrates, an effective estate plan requires that you also effectively deal with superannuation entitlements, particularly since these entitlements can be the most major asset of the estate. You should therefore ensure you obtain appropriate legal and financial advice in respect of dealing with who receives your superannuation entitlements on death and minimising any taxation impacts. 

[1] The enduring power of attorney commentary is based on Queensland laws. Every State has similar legislation but the formalities and form of the enduring power of attorney may differ and you should check with a lawyer in the relevant jurisdiction.

[2] In Queensland, an attorney must themselves have a capacity, be over 18 years and not be your paid carer (or not have been your paid carer in the past 3 years), your health provider, a service provider for a residential services where you live, or bankrupt.

[3] Refer section 17A (3) (b) Superannuation Industry (Supervision) Act 1993 Act. 

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