Will you inherit someone's super after they die?
Nobody ever wants to pay more tax than necessary. Hidden taxes seem to be everywhere, for the unaware. Even when you die, like a seagull swooping on a hot chip, the tax office will be quick to intervene and take a cut of your super death benefit, if you aren’t careful.
It pays to understand what you can do to reduce the stress (and the tax) at this difficult time.
Read in this article
- So what happens to a person's super when they die?
- Two super amounts, in one payment
- Beneficiaries, Adult Children, and Changing Tax Laws
- Who arranges for the tax payment on a death benefit payment?
- The bottom line
- FAQ's
- I lent my kids money for their house deposit with a simple "pay me back when you can" agreement. We never wrote anything down. Is that really a problem?
- Why on earth would the Tax Office tax my child for money I decided to forgive? It was my money to begin with!
- What exactly do you mean when you say the Tax Office acts like a 'seagull'?
- So, if I want to give my kids a significant amount of money, what is the legally 'safe' way to do it to avoid this tax nightmare?
- What's the worst-case scenario if we just leave our informal family loan as a 'verbal agreement' and hope for the best?
- Sources & Further Reading
So what happens to a person's super when they die?
If you inherit someone's super after they die, the person's super fund pays you a super death benefit payment. In most cases, their super is paid to their dependents. Otherwise, their super can be paid to their estate.
Warning: You may have to pay tax on some of these benefits.
Two super amounts, in one payment
A super death benefit payment is made up of the deceased person’s:
- super account balance, and if they had death or disability insurance cover
- any insurance benefit that has been paid to the super fund
So even if the deceased person didn’t have much super, the insurance payment could be worth thousands of dollars. So this makes it important to think about who should receive the death benefit, and if there are any special rules about when it's paid tax-free, and when it's taxed.
Beneficiaries, Adult Children, and Changing Tax Laws
One of the main issues when it comes to the tax treatment of a death benefit payment is who is legally a dependant (and it is not always who you think). The next issue is how much tax is due.
Tax definition of a dependant
- If you are a dependant of the deceased, you do not need to pay tax on the taxable component of a death benefit if you receive it as a lump sum.
Tax treatment of a death benefit payment
- If you are not a dependant of the deceased, you can only receive the benefit as a lump sum and the super fund trustee usually calculates and deducts the tax due.
The two components of a super payout
The taxable component of the payment will be entitled to a tax offset that ensures the rate of income tax is as follows:
- taxed element (usually SG contributions) – maximum of 15% plus Medicare levy currently 2% of your taxable income
- untaxed element (usually personal contributions) – maximum of 30% plus Medicare levy currently 2% of your taxable income (Read more at ATO)
Death benefit lump sums paid to a non-dependent, via a deceased estate, are also taxed as per the tax rates but the Medicare levy isn't required. The super fund is still required to calculate the components but it is the deceased estate that withholds the tax.
Pro Tip: When a person dies, in most cases their super fund pays their remaining super to their nominated beneficiary, or if no beneficiary has been nominated, to the trustee of a deceased estate, after the member has died. Super paid after a person's death is called a 'super death benefit'.
Who arranges for the tax payment on a death benefit payment?
The trustee of the super fund paying a death benefit payment may make inquiries of the nominated beneficiaries and may deduct tax accordingly, based on an individual beneficiary dependency status. The Trustee of a Self Managed Super Fund (SMSF) will need to make their own calculations and report their actions to the ATO.
The bottom line
Because taxation of death benefits can be complicated, you should always seek financial advice.
FAQ's
Your Super and Inheritance Questions, Answered. Here’s a quick summary of what you need to know about Superannuation payouts and Inheritance expectations .
I lent my kids money for their house deposit with a simple "pay me back when you can" agreement. We never wrote anything down. Is that really a problem?
That's the classic scenario, and unfortunately, yes, it can become a very big problem. While it feels like a simple family arrangement, the Australian Taxation Office (ATO) sees things in black and white. Without a formal document, that "loan" is legally a debt. The danger arises later on. If you decide to formally forgive that debt—or if it's forgiven in your Will when you pass away—the ATO can treat the forgiven amount as income in your child's hands, landing them with a surprise tax bill that could be tens of thousands of dollars.
Why on earth would the Tax Office tax my child for money I decided to forgive? It was my money to begin with!
It seems illogical, doesn't it? The reason is that under Australian tax law, the "forgiveness of a commercial debt" can be treated as assessable income. While you might see it as a family matter, the ATO can view any undocumented loan as a "commercial" arrangement. By forgiving it, you are essentially giving your child a financial gain that the ATO believes it has a right to tax. You intended to give them a gift, but without the right paperwork, you've accidentally created a tax event.
What exactly do you mean when you say the Tax Office acts like a 'seagull'?
Think about it like this: you're sitting on the beach enjoying your hot chips (the inheritance or financial gift you're giving your family). Everything is fine until a seagull (the Tax Office) swoops in unexpectedly and snatches a huge portion of it right out of your hands. The seagull doesn't care that they were your chips; it just saw an opportunity. The ATO operates in a similar way with these informal loans. It sees the 'forgiveness of debt' as an opportunity to claim its share, swooping in on a family transaction and taking a chunk that no one ever expected to lose.
So, if I want to give my kids a significant amount of money, what is the legally 'safe' way to do it to avoid this tax nightmare?
The solution is to be clear about your intentions from the very beginning by using the right legal documents. You have two excellent options: A Deed of Gift: If you intend the money to be a gift from day one, you document it this way. This makes it clear to everyone, including the ATO, that there is no debt to be repaid or forgiven. A Proper Loan Agreement: If it is a genuine loan, you should have a formal loan agreement that includes a "forgiveness clause." This clause can be structured to allow you to forgive the debt without triggering a tax event for the borrower. Either way, a clear document removes all ambiguity and protects your family from the "seagull."
What's the worst-case scenario if we just leave our informal family loan as a 'verbal agreement' and hope for the best?
The worst-case scenario often happens upon your death. Your Will might state that any debts owed to you by your children are forgiven. The executor, following your instructions, formalises this forgiveness. Shortly after, your child receives a notice of assessment from the ATO for the forgiven amount, demanding tax is paid on it as income. At a time when they are grieving, they are suddenly hit with a massive, unexpected tax bill that can force them to sell assets or take out another loan just to pay the Tax Office. It turns your intended gift into a significant financial burden.
Sources & Further Reading
- Commercial Debt Forgiveness Rules: Division 245 of the Income Tax Assessment Act 1997. This section outlines how the forgiveness of a commercial debt can have tax consequences for the borrower.
INCOME TAX ASSESSMENT ACT 1997 - DIVISION 245 - ATO Guidance on Debt vs. Gift: The Australian Taxation Office (ATO) provides guidance on how it distinguishes between a genuine gift and a loan. This is critical in determining whether a transaction creates a debt that can later be forgiven.
ATO - Is it a gift or a loan? - Taxation Ruling on Debt Forgiveness: While technical, Taxation Ruling TR 96/8 provides insight into the Commissioner's view on what constitutes the forgiveness of a debt for the purposes of the law, including informal arrangements.
Taxation Ruling TR 96/8 - Income tax: commercial debt forgiveness - Legal Requirements for a Deed of Gift: For a gift to be legally effective and unambiguous, it is often documented in a Deed. State legislation, such as the Conveyancing Act 1919 (NSW), outlines the requirements for creating a valid deed.
Conveyancing Act 1919 (NSW) - Section 38
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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.
