Whenever I make a speech to retirees, I talk about the death tax of 15% (or 17% when it includes the Medicare levy), which can apply to superannuation death benefits. Most people have never heard of it, and believe that Australia doesn’t have death duties.
Well, I guess it is not, strictly speaking, a ‘death duty’, but the effect is the same. So take the time to get your head around it, as it’s an easy tax to minimise with a bit of planning.
Value of a re-contribution strategy
The first thing to understand is that it applies only to the taxable portion of your superannuation fund that is given to a non-dependant. A spouse is always a dependant whether they have a separate income or not.
It does not apply to the tax-free portion of your super, so those over 60 and still eligible to contribute to super could take advice about adopting a withdrawal and re-contribution strategy. This involves taking out a chunk of your super tax-free, and then contributing it back as a non-concessional contribution.
There is no cost involved, as there is no entry tax on these contributions, and it effectively converts the amount re-contributed into a tax-free component. But watch the contribution limits as there are big penalties for exceeding the caps.
The next thing to understand is that you cannot elect to withdraw just from the taxable component. If your balance is partly taxable and partly non-taxable, the components of the withdrawal will be in the same ratio as your existing balance.
Taxable components of a tax-free fund
Many retirees are in pension phase, which means the earnings on their fund are tax-free, as are the withdrawals if they are aged 60 or over and eligible to withdraw. However, the tax-free status of the fund does not mean that all the components become tax-free as well. There will almost certainly still be taxable and non-taxable portions of the components, with the death tax applying to the taxable component when paid to a non-dependant.
One reader asked if the death tax could be avoided by leaving the money to a charity. There is no joy here, as a charity is treated in the same way as a non-dependant. A much better option for anybody who wants to leave money to charity would be to withdraw it from superannuation before they die, make an immediate donation and claim a tax deduction.
However, if you are receiving Centrelink benefits, take advice before doing this, because the gift could be regarded as a deprived asset if it is over $10,000.
Strategies for avoiding death taxes
So, if the tax does apply, how is it calculated? It is a maximum of 17%, not a flat 17%, and is deducted by your superannuation fund before paying your beneficiary the death benefit. The tax paid is recorded on a PAYG payment summary (similar to wages). When your beneficiary lodges their personal tax return, the assessable amount received and PAYG withheld must be reported. If they have a high income, or if the sum is large, the tax is rebated so that no more than 17% is payable. If they have a low income, they may receive a refund of the tax paid by your super fund.
If you are considering a binding nomination, make sure you clearly understand the implications before setting it up. Once a valid binding nomination is in place, the trustee may lose the discretion to distribute the proceeds of the deceased’s superannuation fund in the most tax-effective manner.
The simplest way to avoid the death tax is to make sure you have given a trusted person an enduring power of attorney, with instructions to withdraw your superannuation in full if it appears that death is imminent. There would be no tax on the withdrawal, and the money could then be distributed in accordance with the terms of your will after your death.
Noel Whittaker is a leading financial adviser and the author of Making Money Made Simple and numerous other books on personal finance. Noel writes an excellent monthly newsletter and a free subscription is available on this link.