Who said “ DEATH TAX ” was dead and buried??
There’s a misconception among SMSF trustees who believe their adult children will receive all their superannuation savings, upon their death, totally tax-free. The mere fact the adult children are classified as a “dependant” under the superannuation law, doesn’t mean they will receive the benefit tax-free.
The way the superannuation and income tax laws interact can be confusing. SMSF members who don’t understand the law could end up leaving their loved ones with a big tax bill. I’ll outline how the superannuation and income tax laws impact on death benefits.
The superannuation law states who can be paid a death benefit upon the death of an SMSF member, while the income tax law states how the death benefit will be taxed, based on who receives it, and whether the benefit is paid as a lump sum or an income stream (i.e. pension).
It is important to note the two laws also differ on the definition of a “dependant”…Confused?
Under the superannuation law, a “dependant” is:
- a spouse by marriage;
- a de facto partner;
- same-sex partner;
- a child of any age; and
- anyone who had an interdependent relationship with the deceased.
An interdependent relationship is where two people (whether related or not) have a close personal relationship and live together and provide financial or domestic support and personal care.
The superannuation law also states that a death benefit pension can only be paid to the deceased member’s dependant and in the case of a child it can only be to a child who is less than 18 years of age, or is aged 18 to 24 and was financially dependent on the deceased before their death. A child of any age with a disability is also eligible.
Under the income tax law, a dependant in relation to a death benefit is referred to as a “death benefit dependant”. A death benefit dependant can be the deceased’s:
- spouse by marriage;
- a de facto partner;
- same-sex partner;
- a child under the age of 18;
- a person who is financially dependent on the deceased person before they died; or
- a person with whom the deceased person had an interdependent relationship with just before their death.
Unlike the superannuation law, the definition also includes a former spouse.
Better check your 20 year old Will!
A person classified as a dependant under the superannuation law can receive an SMSF member’s death benefit in accordance with the deceased’s SMSF trust deed and/or as per the deceased’s binding death benefit nomination. People who do not meet the definition of a dependant (for example: siblings, grandchildren, parents, friends) can only receive the deceased’s superannuation via the deceased’s estate in accordance with the deceased’s Will.
The tax treatment of a death benefit depends on who receives the benefit and whether the benefit is paid as a lump sum or a pension. If the recipient of a death benefit is classified, under the income tax law, as a “death benefit dependant” and receives the benefit as a lump sum, then regardless of the components of the lump sum, the entire death benefit is tax-free. Yippee!
If the recipient who received the lump sum death benefit is not classified as a “death benefit dependant”, then while the tax-free component of the lump sum will still be tax-free, the taxable component of the lump sum will attract tax at the maximum of 15% plus the Medicare Levy. Bummer!
The tax treatment of a death benefit pension depends on the age of the deceased, the age of the recipient and the components of the pension.
- If the benefit is paid to a “death benefit dependant”, and either the recipient or the deceased are over the age of 60, then both the tax-free and taxable components of the pension will be tax-free;
- If, however, both the dependant and the deceased are under the age of 60, then the taxable component of the pension will be taxed at the recipient’s marginal tax rate with a 15% tax offset.
Trustees should also bear in mind that under the superannuation law, the death of an SMSF member will trigger a compulsory payment situation. That means, the trustees of the SMSF have no choice but to pay out the deceased’s benefit, the SMSF can’t retain it.
It is of vital importance that you review your beneficiary nominations regularly. Please contact Optima Partners for any additional information you may require.