Taxation of Superannuation and Death Benefits Payments: What can happen to my superannuation fund balance if I die?

In Australia, superannuation guarantee (or “super”) is an employer contribution-based system designed to help individuals save for retirement. As superannuation assets and individual balances continue to grow, many Australian families may face an unpleasant surprise upon the death of a loved one, with a tax bill of potentially 17%, and in some cases, as high as 32%, possibly applying to the deceased’s superannuation fund balance. It is important to note that Superannuation does not automatically form part of the deceased estate, which creates unique challenges for both planning and compliance. Understanding this is essential, especially in light of the broader superannuation guarantee obligations that govern how funds accumulate and are distributed over time.

Who can receive a death benefit of superannuation?

When a person passes away, their super fund typically distributes the remaining super to their nominated beneficiary, either via a binding or non-binding nomination. This distribution, paid after death, is known as a superannuation death benefit.

If the deceased did not make a nomination, or made a non-binding nomination, the trustee of the fund may:

• Use their discretion to decide which dependents (s) will receive the death benefit, or
• Pay the benefit to the deceased’s legal personal representative (executor of their estate) for distribution according to the deceased’s will.

If a death benefit is paid to a dependant, it can be provided as either a lump sum or an income stream. However, if the death benefit is paid to someone who is not a dependent, it must be issued as a lump sum.

Critically, Superannuation Law and Taxation Law differ in the treatment of dependents as follows.

Dependants under Superannuation Law

You are considered a dependant of the deceased under Superannuation Law if, at the time of their death, you were:

• Their spouse or de facto spouse
• A child of the deceased (of any age)
• A person in an interdependent relationship with the deceased.

An interdependency relationship exists between two people if all the following conditions are met:

• They share a close personal relationship
• They live together
• One or both provide financial support to the other
• One or both provide domestic support and personal care to the other.

Dependants under Taxation Law

For tax purposes, you are considered a dependant of the deceased person if, at the time of their death, you were:

• Their spouse or de facto spouse (of any gender)
• A former spouse or de facto spouse (of any gender)
• A child of the deceased under 18 years old
• In an interdependency relationship with the deceased
• Any other person who was financially dependent on the deceased.

The conditions for an interdependency relationship under tax law are generally the same as those under superannuation law however, there are different conditions if one, or both, suffer from a physical, intellectual or psychiatric disability.

Components of Superannuation Death Benefits

Death benefits generally consist of two components: the Taxable Component and the Tax-Free Component.

1. Taxable Component: This is usually the larger portion and includes concessional contributions made during accumulation (e.g., employer contributions) as well as investment earnings on these amounts. This component can be made up of a taxed element and an untaxed element.
2. Tax-Free Component: This portion typically includes non-concessional contributions made with after-tax dollars, such as personal contributions.

Tax on Death Benefits

When a superannuation fund member passes away, the death benefit amount is distributed to the nominated beneficiaries, who can be dependents or non-dependents depending on individual circumstances. The ultimate tax treatment depends on the recipient’s relationship to the deceased and the components of the super benefit to be paid.

1. Death Benefits Paid to Dependents

When a superannuation fund member passes away, the death benefit amount is distributed to the nominated beneficiaries, who can be dependents or non-dependents depending on individual circumstances. The ultimate tax treatment depends on the recipient’s relationship to the deceased and the components of the super benefit to be paid.

For dependents, the tax treatment on the death benefit is as follows:

• Tax-Free Component: This part of the death benefit is paid tax-free, regardless of the beneficiary’s relationship to the deceased.
• Taxable Component: If paid to a dependent, the taxable component is generally tax-free as well.

2. Death Benefits Paid to Non-Dependents

A non-dependent includes adult children who are not financially dependent on the deceased, as well as other common beneficiaries such as siblings, friends, or other relatives.

For non-dependents For non-dependents, the tax treatment on the superannuation death benefit is more complex and potentially costly. This is particularly relevant for individuals with international ties or residency considerations—read our guide to Australian tax on foreign super lump sum withdrawals 

for more insights on cross-border tax treatment of super benefits, the tax treatment on the superannuation death benefit is more complex and potentially costly:

• Tax-Free Component: As with dependents, the tax-free component is paid out without tax to non-dependents.
• Taxable Component: The taxable component of a death benefit paid to a non-dependent is subject to tax at 15%, plus the Medicare Levy of 2% on the taxed element, and 30%, plus the Medicare Levy of 2% on any untaxed element.

Essentially, this means that death benefit payments to non-dependents attract tax consequences on the taxable component, resulting in an inefficient tax leakage.

Is there a way to reduce the tax implications to my beneficiaries when I die?

Dependents, particularly spouses and children under the age of 18, are generally treated more favourably, being tax-exempt on both the tax-free and taxable components of the benefit. Non-dependents, however, such as adult children, face more substantial tax liabilities, especially when the taxable component is involved.

Whilst detailed advice taking into account your specific facts and circumstances should be obtained, those with a large superannuation balance should consider the proposed changes targeting large superannuation balances as part of their estate planning strategy. These changes may affect how super is taxed and highlight the importance of reviewing recontribution strategies, super withdrawals, or testamentary trusts.

For those with a large superannuation balance, consideration should be given to the different options  available in order to try to minimise the potential tax impact of death benefit payments, including:

• Removing amounts from superannuation funds
• Considering the provision of gifts prior to death
• A recontribution Strategy in order to increase the tax-free component
• Superannuation testamentary trusts (STTs)

Navigating the tax implications of superannuation death benefits is crucial to effective estate planning. Early consultation with an independent financial planner and a relevant tax professional is vital to help maximize the value of superannuation death benefits and minimise the potential tax burden on your beneficiaries, including any ultimate tax leakage.