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Death And Taxes
DO
BENEFICIARIES HAVE TO PAY TAX ON SUPERANNUATION LUMP SUM DEATH BENEFITS?
Superannuation
benefits are likely to become a person's most valuable assets. Having an
estate plan in place can reduce the likelihood that, after death, the
recipients of those superannuation benefits will have to pay tax on the
benefits. It could make a substantial difference to the amount they
receive.
A lump sum death
benefit may take the form of either:
-
a lump sum
payment from a superannuation fund when a person dies, or
-
a payment from
an employer (in which case it is known as a 'Death Benefit Termination
Payment')
A superannuation
lump sum death benefit is taxed differently from withdrawals made from
superannuation while someone is alive. In certain circumstances, it may be
tax-free.
WHO CAN
RECEIVE BENEFITS?
If someone has
benefits in the superannuation system when they die, there are rules that
restrict who those benefits may be paid to after their death. The
superannuation fund trustee must observe these rules before taking into
account any instructions provided.
One option is
for the benefits to be paid as a lump sum. The superannuation fund trustee
can pay the lump sum directly to a recipient, or the amount can become
part of the person's deceased estate, to be distributed to beneficiaries
in accordance with their Will.
The alternative
is for the benefits to be paid out of the superannuation system to the
recipients in the form of a pension. It is only possible to pay the
benefit as a pension to a 'death benefits dependant' defined as follows:
A 'death
benefits dependant' includes:
-
a spouse
-
children of
the deceased who are under 18 years of age
-
any person who
is financially dependent on the deceased at the time of death (other
than children over the age of 25)
-
any person
with whom the deceased had an interdependency relationship.
If benefits are
to be paid to a recipient who is not a death benefits dependant, they must
be paid as a lump sum.
Children over
the age of 18 who are not financially dependent are not death benefits
dependants.
Death benefit
pensions paid to children must be commuted once the child attains 25 years
of age (unless the child is permanently disabled).
HOW LUMP SUM
BENEFITS ARE TAXED
A lump sum death
benefit may be tax-free, taxed in the recipient's hands, or a person's
estate may be taxed on it. The tax treatment of the death benefit depends
on:
-
whether the
benefit is paid directly to the recipient or becomes part of the
deceased estate and is then paid to the beneficiary named in the Will
-
whether the
recipient is considered a death benefits dependant
The Better Super
reforms (applicable from 1 July 2007) removed the 'excess benefits tax',
so that the size of the death benefit is no longer a factor in how it is
taxed. When will a
lump sum death benefit be tax-free?
A lump sum death
benefit will be tax-free if the benefit is received by a death benefits
dependant. The tax-free status applies regardless of whether the benefit
is paid directly to the recipient or paid into the deceased estate and
then distributed to the beneficiary. However, if the benefit is to be paid
into the estate, it must be clearly stated in the Will that the death
benefit is to be allocated only to death benefits dependants in order for
the benefit to be received tax-free. Otherwise, the Australian Taxation
Office is likely to allocate the death benefit pro-rata across
beneficiaries of the estate in accordance with their entitlements to the
estate residue.
For example, if
a testamentary trust is established in a Will, the death benefit should
either be specifically excluded from the trust or only death benefits
dependants should be potential beneficiaries.
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What if the
recipient of a lump sum death benefit is not a death benefits dependant?
A recipient who
is not a death benefits dependant will be taxed on a Lump sum death
benefit as follows:
-
the 'exempt
component' will be tax-free
-
tax on the
'taxable component' will be capped at either 16.5 percent including
Medicare levy (for the 'element taxed in the fund') or 31.5 percent
including Medicare levy (for the 'element untaxed in the fund')
No portion of
the taxable component of the death benefit will be tax-free. There is a
concessionally taxed portion (known as the 'low rate cap') associated with
lump sum withdrawals from superannuation, but this is not available on a
death benefit.
The higher tax
rate of 31.5 percent applies when the taxable component represents an
'element untaxed in the fund'. The taxable component is generally only in
this form if the death benefit includes life insurance proceeds or is
being paid from a Public Service Superannuation Scheme.
If the lump sum
death benefit is paid into an estate for distribution, rather than
directly to the beneficiary who is not a death benefits dependant, the tax
treatment is the same except that:
-
the trustee of
the estate is liable for tax on the death benefit, rather than the
beneficiaries, who eventually receive the after-tax proceeds
-
the deceased
estate is not required to pay the Medicare levy.
IMPACT OF
BETTER SUPER REFORMS
The Better Super
reforms (applicable since 1 July 2007) introduced several changes to the
taxation treatment of death benefits. These changes, which impact both
lump sum death benefits and death benefits paid as pensions, include:
Before 1 July 2007, an RBL
represented the total amount of concessionally taxed benefits that an
individual could receive from the superannuation system. RBLs are no
longer a factor in determining the tax treatment of a death benefit.
It is now only possible to pay a
pension from the superannuation benefits of a deceased member if the
pension recipient is a death benefits dependant. Where a pension is
already being paid to the member before their death, the reversion of that
pension is now only permitted if the reversionary beneficiary is a death
benefits dependant, regardless of when the pension was first commenced.
Death benefit pensions paid to children must be commuted once the child
attains 25 years of age (unless the child is permanently disabled).
KENT AGARS, HEAD OF TECHNICAL AND SUPPORT, AUSTRALIAN EXECUTOR TRUSTEES
Kent Agars is head of technical and support with Australian Executor
Trustees. For more information, contact Kent on (02) 9028 1000 or visit <www.aetlimited.com.au>
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