Did you know that despite there being no official ‘death tax’ or ‘death duty’ in Australia, there can be significant tax payable on superannuation benefits that are paid out as part of an inheritance?
The issue is that the complexity of superannuation rules and the associated jargon means that this tax is not widely known or understood. The tax on super inheritances can be significant with the tax rate generally 17% (and this rate varies due to the complexity of super rules) applied to the majority of the super balance in most cases (again with added complexity in what part of the super balance is subject to tax).
Even in the most difficult of personal circumstances, giving money to the tax man unnecessarily is a major pain. It can be costly to get advice and superannuation is often not considered in estate planning (as super usually doesn’t form part of your estate). However, if you understand a few key points listed below, you may be able to reduce tax substantially. Note that the points below are general in nature, related to tax consequences of super inheritance only and are not financial advice. Please contact a financial advisor to discuss your situation if appropriate.
Avoiding inheritance tax on superannuation
1. The first thing to note is that if there’s
a. a super inheritance paid as a lump sum to what the ATO term a ‘non tax dependent’, whom is generally a child over 18 or other adult beneficiary who is not the spouse, ex-spouse or financial dependent of the deceased (note this is a technical area with myriad rules and professional advice should be obtained to assess the status of beneficiaries in relation to super tax. See this link for ATO details https://www.ato.gov.au/tax-and-super-professionals/for-superannuation-professionals/apra-regulated-funds/paying-benefits/paying-superannuation-death-benefits#ato-Dependants), and
b. the super inheritance consists of amounts that were employer or personal deductible contributions (which will be the majority of super balances in most cases and is known as the ‘taxable component’ of the super amount), then
c. Tax on the taxable component of the super payment to the beneficiary will be paid at 15% plus the 2% medicare levy. The taxable component is often the majority of the payment, resulting in potentially significant tax.
For example, a $2M super benefit in the scenario above that consists of $1.5M of taxable components will result in tax of $255,000. A $1M super benefit consisting of $800k which is subject to tax will result in tax of $136,000.
2. Secondly, tax can be reduced if
a. Super is withdrawn before passing away, so that the funds are part of the estate and are not subject to any death duties or taxes. Obviously the timing of this is a major issue given no one knows when they will pass away. However, given the fact that we will all pass away at some stage, if we are prepared to plan for this, then tax savings can be substantial. There may some tax to pay on earnings after the super is withdrawn, however this may be significantly less than the tax on super, depending on the amounts, taxable components and where the super withdrawal is invested.
For example, a current term deposit rate may be 4.8%. $1M invested at this rate results in interest received and taxable income of $48,000. If there’s no other income and the seniors and pensioners tax offset is available, personal income tax will be approximately $6,500. If this tax was paid for a number of years before passing away, it would still be significantly less than the $136,000 of tax mentioned above. There are planning considerations in relation to the growth of the super balance during this time, however from a tax perspective, having the super balance withdrawn from super before passing away can result in significant tax savings.
3. A further option around avoiding inheritance tax on super may be to withdraw super and then put it back into super as a non-taxable (“non-concessional”) contribution. This changes the proportion of the super balance that is subject to tax. The higher the proportion of non-taxable contributions that make up the total super balance, the lower the amount of the super balance that will have tax applied. Note there are myriad rules around a super withdrawal and recontribution strategy including age-based rules that determine whether you can do this and professional advice is strongly recommended.
To assess your situation further, you need to consider the age based rules and what your options are, the extent you want to engage in a strategy to reduce tax and the degree to which your super balance consists of portions that will be subject to tax and that are tax free. All of this may necessitate talking to your super fund for details about your funds balance and the tax components, along with a financial adviser about your options. For further reading, here are some links with further information.
https://moneysmart.gov.au/how-super-works/tax-and-super
If you can plan for super inheritances and work with an adviser, you may able to save significant amounts of tax. Note that as mentioned above I’m not licenced as a financial adviser so can only advise on tax implications of different scenarios rather than provide more comprehensive advice. Hopefully this article has provided you with some knowledge to take forward and possibly reduce your tax. If you want a referral to a financial planner, let me know or let me know if you have any questions.