Is defacto inheritance tax hiding in your Super payout?

When is an inheritance tax not called inheritance tax?
When it's a super death payment tax of course!

Like to know more? Well, you should because this tax problem has special meaning for people with super, and adult children of people with super.

If you plan on leaving your superannuation to your now adult kids when you pass away, there's a strong possibility your super death benefit payout will be hit with tax.

This is even though you could have received that same benefit in your own hands tax-free when you're over 60.

Read in this article

Unfair you might say?

A lot of people say that and we'd agree.

The law can sound confusing as Super laws and Tax laws seem to overlap in this important area.

• A financially independent adult child is considered a super-dependant under the super laws.
• But at the same time is considered a tax-non-dependant under the tax laws.

This means, that a financially independent adult child of the recently departed, while they can legally receive the death benefit payout from the decease's super fund, will be required to pay tax on the amount.

Tax Insights: The tax treatment of death benefit lump sum payments from super funds disadvantages non-dependants such as adult children. Adult children can find themselves paying between 17% and 32% tax on a lump sum payment received from a parent’s super fund.

Sounds confusing?

Simply put it means this:

• If any of your kids are now aged 18 or over and can’t prove they're financially dependent upon you (or severely disabled) to the satisfaction of the Super Funds’ Trustee, then they're considered tax-non-dependents under the tax laws.

As a result, the tax will be withheld by the Super fund Trustee on any super death amount they receive.

Caution: If the super death payout comes directly from a Super fund to the deceased's estate, the estate's Executor looking after the Will is required to calculate and pay the tax. This is a potential minefield, so get financial advice.

Why does this happen?

The amount of tax to be paid by a tax-non-dependant adult child is determined by a number of issues including whether the funds coming out of the deceased's super account were classified as from a taxable component of the funds.

While this is beyond the scope of this article, this is an important area where we can provide advice and strategy to reduce the tax being paid.

Tips for Super Fund members

• Understand if your super death benefit is paid as a lump sum payment to a person who's classed as a tax-dependant, then the benefit is tax-free.
• Understand if it's paid to a tax-non-dependant, tax is payable from the taxable component at a rate of 15% (plus Medicare levy) up to 32% if the taxable component contains an untaxed element.
• So allow for the potential tax effect in your future plans.

Case Study: Terry had a typical super fund account and nominated his two kids to receive the balance of his super fund upon his death. When he first opened the fund, they were both under 18.

Both his kids are now adults 35 and 37 and living independently.

• Terry died and left $500,000 in his super (taxable component) and it was paid to his two now adult children.
• This means his kids are now adults and considered tax-non-dependants.
• Upon Terry's death, his super balance was $500,000.
• His death benefit payout was reduced to $415,000 and split between his two children
• The tax office collected 17% of the total benefit - $85,000.

This was because Terry's children are now adults and considered tax-non-dependants to Terry.

If Terry had additional life insurance in his super as well, then the insurance payout can be taxed at 32% (30% benefit tax plus 2% Medicare levy).

What should you do, now you know this?

If you plan on leaving your superannuation to your kids when you pass away, understand when tax on a super death benefit payout becomes an issue.

If you’re also paying for life insurance from your super fund, understand the effect of children turning 18 years and becoming no longer financially dependent, has on your future estate plans.

• If your kids are under 18, speak with us about when you should increase your life insurance by 30% to cover taxes later
• If your kids are now 18 or over, speak with us about either increasing your insurance by 30% to cover the tax or use a special financial strategy to manage this unfair taxation issue.
• If you're the adult child of a parent who is planning on leaving you the unused portion of their super as part of an inheritance, understand a financial strategy might be able to reduce that tax to nil.

Drew Browne is a specialty Financial Risk Advisor working with Small Business Owners & their Families, Dual Income Professional Couples, and diverse families. He's an award-winning writer, speaker, financial adviser and business strategy mentor. His business Sapience Financial Group is committed to using business solutions for good in the community. In 2015 he was certified as a B Corp., and in 2017 was recognised in the inaugural Australian National Businesses of Tomorrow Awards. Today he advises Small Business Owners and their families, on how to protect themselves, from their businesses.  He writes for successful Small Business Owners and Industry publications. You can read his Modern Small Business Leadership Blog here. You can connect with him on LinkedIn.  Any information provided is general advice only and we have not considered your personal circumstances. Before making any decision on the basis of this advice you should consider if the advice is appropriate for you based on your particular circumstance.