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Payment of death benefits from superannuation

The payment of death benefits from superannuation can be a complex area of advice. There are different methods of paying a death benefit (lump sum vs pension) and potential tax implications to consider. In this article, we attempt to explain death benefits from superannuation as simply as possible, but please forgive us if we stray a little into the realm of complexity and leave you scratching your head.

What makes up a death benefit payment

Your superannuation death benefit will be made up of your accrued super balance plus any life insurance benefit you may hold through super.

You direct who receives this benefit in the event you were to pass away by nominating a beneficiary(ies). If you chose to nominate an individual person(s) then this death benefit payment does not form part of your estate. It bypasses the will, and is paid directly to the nominated beneficiary.

Consider who is a dependent

When nominating a beneficiary, you can’t just list anyone. There are rules you have to abide by or the beneficiary nomination will be deemed invalid. Given this, it is important to consider who is eligible to receive your death benefit and for that, we turn to the Superannuation Industry (Supervision) Act (SIS Act).

A superannuation death benefit can only be paid to someone who is classified as a dependant under the SIS Act. In addition to the SIS Act, you should also consider who is classified as a dependent under the Income Tax Assessment Act (ITAA) as this will determine if there is any tax payable on the death benefit (more on this later).

Ideally, you are looking for someone who is classified as a depend under both acts. This will mean the nominated person(s) is eligible to receive the payment and no tax will be payable (if paid as a lump sum). This includes your spouse, child under the age of 18 or a person whom you are in an interdependency relationship with, i.e. you live together and provide each other financial, domestic, and personal support.

The table below illustrates the overlap and differences between the SIS Act and ITAA.

Super and Tax DependentsSIS ActITAA
Spouse (including de facto)YesYes
Former spouseNoYes
Child under age 18YesYes
Child aged 18 or overYesNo
Financial dependant (including adult child)YesYes
Interdependency relationship (including adult child)YesYes
Recipient of a super lump sum in the line of duty.NoYes

As you can see from the table above, a child of any age is a SIS dependent but only a child under the age of 18 is a tax dependent. A former spouse is considered a tax dependent but only a current spouse is considered a SIS dependant. This means you could pay the benefit to an adult child with tax penalties, but you couldn’t pay the benefit directly to a former spouse (would need to go via the estate).

If you don’t have any dependents under this SIS Act, your superannuation will be passed onto your legal personal representative which is the person who will be administering your estate, i.e. the executor of your will if you have a will.

Payment of death benefits

A death benefit can be paid as either a lump sum or, in some instances, an income stream.

Where the deceased member’s super balance is not currently in pension phase, only the following beneficiaries can receive the death benefit as an income stream:

  • Spouse or de facto;
  • Child under 18;
  • Child aged 18 to 25 and is financially dependent;
  • Child that is permanently disabled;
  • Financial dependent (other than a child); and
  • A person in an interdependency relationship with the deceased.

Where the death benefit is paid as an income stream to child under the age of 18, the income stream must be commuted to a lump sum when the child reaches age 25, unless they are permanently disabled. 

If the death benefit is being paid from an existing superannuation income stream, such as an account-based pension, it may continue to be paid to a reversionary beneficiary if one is nominated.

Please be aware that any time a death benefit is paid as a pension, you need to consider the transfer balance cap (TBC) of the recipient. This may restrict how much of a death benefit can be used to commence a death benefit pension and, in some cases, result in an amount being forced out of the super environment.

If the beneficiary already has an existing pension, and subsequently their own transfer balance account, there must be sufficient space left in the TBC in order to receive the death benefit as an income stream. If not, it will need to be paid out as a lump sum.

When it comes to children receiving death benefit income streams, there are specific rules and limits that apply to ensure compliance with the TBC.

Taxation of benefit payments

Whether or not a death benefit is taxable will depend on a number of factors, including the following:

  • whether the payment is taken as a lump sum or an income stream;
  • whether the beneficiary is a dependant for tax purposes; and
  • if taken as a death benefit pension, the age of the deceased at death and the beneficiary’s age at payment; and

If a payment is taxable, you also need to understand the components that make up a super fund to calculate the tax payable. There are three components that can potentially make up a super balance as follows:

  • Taxable Taxed. Derived from concessional contributions and investment returns.
  • Taxable Untaxed. Derived from some death benefit insurance payments and money from an untaxed superannuation scheme like GESB West State Super.
  • Tax-Free. Derived from non-concessional contributions, government co-contribution, low-income super contributions, eligible spouse contributions, contributions under the small business CGT concessions and contributions relating to personal injury payments.

All super funds will be made up of one or a combination of these components. For most people, their super will be primarily taxable as employer superannuation guaranteed contributions (SGC) form part of the taxable component.

The table below summarises the tax treatment of a lump sum payment:

Beneficiary
(tax definition)
Tax-free componentTaxable component
Element taxed
Taxable component
Element untaxed
DependentNilNilNil
Non-dependentNil15% plus Medicare Levy30% plus Medicare Levy

The table below summarises the tax treatment of an income stream payment. Please remember that a death benefit income stream cannot be paid to a non-dependent:

AgeTax-free componentTaxable component
Element taxed
Taxable component
Element untaxed
Deceased and dependent
less than age 60
NilMarginal tax rate + Medicare levy
less 15% tax offset
Marginal tax rate + Medicare levy
Deceased or dependent
age 60 or more
NilNilMarginal tax rate less
10% tax offset

In summary, the tax-free component of your super fund will always be paid out tax-free to a beneficiary whether they are dependent or not and regardless of whether it is paid as a lump sum or income stream. The tax treatment of the taxable component will vary depending on the relationship to the deceased and how the benefit is paid.

Given the very favorable tax treatment where the deceased is age 60 or more, reversionary nominations are a very popular choice where an existing pension account has been started.

Where the trustee of a deceased estate receives a lump sum superannuation death benefit, it is taxed in the hands of the trustee according to whether a dependent or non-dependent is expected to receive the benefit.

Final thoughts

Before nominating a beneficiary on your super fund, it is important you consider the potential tax implications. Ideally, you will be listing someone who is considered a dependent under both the SIS Act and ITAA such as a spouse or child under 18.

If you don’t have a financial dependent, there are strategies that you can implement to help reduce the potential tax payable such as a recontribution strategy.

Disclaimer

The information in this website is for general information only.

It should not be taken as constituting professional advice from the website owner – Guided Investor as Authorised Representative of Symmetry Group (AFSL 426385)

You should consider seeking independent legal, financial, taxation or other advice to check how the information relates to your unique circumstances.

Guided Investor is not liable for any loss caused, whether due to negligence or otherwise arising from the use of, or reliance on, the information provided directly or indirectly, by use of this document.

Brad Buters Financial Planner Perth

Brad Buters

Managing Director | Financial Adviser

Helping Australians achieve financial independence.

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