In Australia, superannuation is one of the most important financial assets for many people. It is a tax-effective way to save for retirement and provides a source of income for when you're no longer working. However, many people don’t realise that when you pass away, your superannuation can be subject to a 'death tax'.

What is the 'death tax' on superannuation?

The 'death tax' on superannuation, also known as the 'superannuation death benefit tax', is a tax that is applied to your superannuation when you pass away. It is taxed at a rate of 15% for taxable components (which includes contributions made from pre-tax income and earnings on those contributions), plus 2% Medicare levy. For example, if you have $500,000 in taxable components in your superannuation, your beneficiaries could be liable to pay a tax of $85,000!

How is the 'death tax' calculated?

The 'death tax' on superannuation is calculated only on the taxable components of your superannuation which is made up of pre-tax contributions (concessional contributions) and related investment earnings on which your fund has paid tax. There is no tax payable on the tax-free component of your superannuation, which is made up of money that has already been taxed (non-concessional contributions). The taxable component of superannuation is taxed at a rate of 17% which comprises of 15% death benefit tax plus 2% Medicare levy (if paid directly to a non-dependent beneficiary). If the beneficiary of your superannuation is your estate (Will) then the 2% Medicare levy is exempt.

How to avoid the 'death tax' on superannuation

There are a few ways to avoid paying the 'death tax' on superannuation:

1. Make use of the superannuation re-contribution strategy

A fundamental of retirement planning, the re-contribution strategy allows people aged between 60-75 (subject to a condition of release if aged between 60-65), to make tax-free capped lump sum withdrawals of their superannuation and then re-contribute it back into super to change its tax status from taxable to tax-free. This means that the recontributed funds are no longer subject to superannuation death benefits tax as their tax status has changed from taxable to non-taxable. This strategy requires careful planning and advice but if orchestrated correctly is a simple and effective means of avoiding the death tax.

2. Withdraw all of your superannuation from your super fund before you die.

While this is theoretically the most straightforward way to avoid the dreaded death tax, having pre-warning that death is approaching and awareness of what to do is obviously critical in order to execute this strategy effectively!

Death benefits tax only applies to money left within superannuation at the time of death. Once your superannuation savings are outside of your super fund (ie. in the bank) they are no longer subject to ‘death tax’. So, if death is imminent and you are capable, you should instruct your advisor or superfund to cash in your super savings immediately. It is also advisable to have a trusted enduring power of attorney appointed with instructions on what to do in the event that you are unable to action this yourself. Ensure your superfund has a copy of the POA documents on file as this can help ensure the process of withdrawing funds goes smoothly and is executed efficiently, as the funds must be withdrawn before death in order to avoid paying the death benefit tax.

3. Nominate a financial dependent as the beneficiary of your superannuation.

If the beneficiary of your superannuation is a financial dependent and they receive your superannuation as a lump sum then they are not required to pay the superannuation death benefits tax. A financial dependent is a spouse or defacto, child under 18, or another person that has an interdependency relationship with you. Adult children are not financial dependents. If you don’t have a spouse, de facto, young children or interdependent there are other way to nominate dependent beneficiaries through more complex estate planning trust arrangements.

Seek professional advice

The rules surrounding superannuation and the death benefits tax can be complex, so it's important to seek professional advice. Your financial advisor can help you to develop a strategy to minimise the amount of tax payable on your superannuation.

In conclusion, the 'death tax' on superannuation can be a significant cost for your beneficiaries when you pass away. By taking steps to avoid it, you can ensure that your hard-earned superannuation is passed on tax-effectively to your loved ones. With the right advice and planning, you can make sure that your legacy is protected.

For more information please contact your Partners Wealth Group advisor.

This information is general in nature and is provided by Partners Wealth Group. It does not take into account the objectives, financial situation or needs of any particular person. You need to consider your financial situation and needs before making any decisions based on this information.