Three-part series

This article is the second in a three-part series setting out practical solutions to common issues in super, tax and estate planning, with a particular focus on the tax impact of payments to beneficiaries.

Taxation of superannuation death benefits

The taxation of superannuation death benefits depends primarily on two things, first whether the recipient is a death benefits dependant, and second the form of the death benefit (ie a pension or lump sum).

“Death benefits dependant” is defined under section 302-195 of the Income Tax Assessment Act 1997 to mean:

the deceased person’s spouse or former spouse; or
the deceased person’s child, aged less than 18; or
any other person with whom the deceased person had an interdependency relationship just before he or she died; or
any other person who was a dependant of the deceased person just before he or she died; or
the payment to any person as a result of the member (who is a member of the defence forces or police) dying in the line of duty

Where a death benefit is paid to an estate of a deceased member whether the death tax is payable will depend on whether the death benefits, under the deceased’s will or intestacy laws, will be paid to a death benefit dependant or not. If it will not, then the estate must pay the death benefit tax.

The following table shows there is a strong tax incentive to pay death benefits to a death benefit dependant, due to the ‘super death tax’ paid by non-death benefit dependants (i.e., up to 17% on the taxable component).

Taxation of lump sum death benefits

Where tax is payable on a super death benefit, and the payment is directly to a beneficiary, the SMSF trustee must withhold the applicable tax from the payment and issue a PAYG payment summary to the recipient in accordance with its PAYG withholding obligations.

If the death benefit is paid to a legal personal representative (eg the executor of an estate) the SMSF trustee does not withhold any tax. Rather, the estate will have to pay any death tax.

Impact of the super ‘death tax’

The below case study shows how the super ‘death tax’ can mean that even where equality between beneficiaries was intended, the net amount received by each beneficiary may differ depending on whether the recipient is a death benefit dependant of the deceased or not.

Case study - achieving equal treatment between super death benefit beneficiaries where not all are death benefit dependants

Carl, age 81, died on 1 July 2024. At the time of his death, Carl was living in Queensland with his spouse, Rachel. Carl also had four children from his previous marriage to Merrit: Rose, Moira, Jamie and Alan.

Rose, Moira and Jamie are independent adults, and are not death benefit dependants of Carl.

Alan is age 20, and is a full time student at Melbourne University. He rents an apartment with friends and is partly supported by Merrit, who has not re-partnered.

Carl had an SMSF with a balance of approximately $2,000,000 and did not make a BDBN prior to his death. Carl’s super was 50% taxable, 50% tax free component. Carl’s will expresses a wish that he wants his super paid equally to his four children upon his death. Carl’s spouse, Rachel, is the sole beneficiary of his will.

The SMSF trustee exercises its discretion to distribute Carl’s SMSF death benefits in accordance with Carl’s wish under his will.

When the SMSF trustee writes to Carl’s children setting out the proposed distribution and stating that the SMSF trustee will be withholding tax from payments, Alan responds to assert that he was financially dependent on Carl at the time of Carl’s death.

Issues:

The wish expressed under Carl’s will did not specify how his super was to be distributed between his four children where different tax treatment might apply depending on the beneficiary
The SMSF trustee has withholding obligations, and if it is not to withhold tax on Alan’s payments, it must be satisfied based on supporting evidence that Alan was financially dependent on Carl at the time of his death
If the SMSF trustee is satisfied that Alan is a death benefit dependant, it must determine how to distribute the super death benefits (for example, seeking to align Carl’s wishes with the different tax treatment of Alan’s portion)

To illustrate, let’s assume that Alan was able to provide evidence to the SMSF trustee’s satisfaction that he was financially dependent on Carl at the time of Carl’s death. This evidence included bank statements showing substantial regular ongoing payments for Alan’s essential day to day living expenses over a period of three years prior to Carl’s death.

Calculations

If the SMSF trustee divides Carl’s $2,000,000 super death benefit equally between the four children, then applies withholding:

The tax withheld amount is calculated as follows:

$500,000 x 50% taxable component = $250,000 taxable component
17% x $250,000 taxable component = $42,500

That is, due to the different tax treatment between beneficiaries, the net amount received by each beneficiary is not 25%, in line with Carl’s wish expressed in his will.

If the SMSF trustee determined to ensure equal net payments between beneficiaries, then Alan will receive a reduced after tax payment (i.e., down from $500,000) to balance the tax withheld from the payments to Rose, Moira and Jamie. While Rose, Moira and Jamie are likely to be happy with this outcome, Alan may not be.

This issue highlights the importance of ensuring that different tax treatment between beneficiaries is considered as part of a member’s death benefit planning.

For example, Carl could have made a BDBN directing the SMSF trustee to distribute his death benefits to his four children, with each to receive an equal share as an after tax amount. While using percentages of total benefit works where, for example, all beneficiaries are not death benefit dependants, it can cause issues where the beneficiaries are a mix of death benefit dependants and non-death benefit dependants.

Alternatively, Carl could have made a BBDN directing the death benefits to his estate. His will could then have provided that the super was to be provided to the children equally on an after tax basis or the will could have provided an adjustment clause that ensured all children received the same amount on an after tax basis.

Phil Broderick
Principal
T +61 3 9611 0163 l M +61 419 512 801
E pbroderick@sladen.com.au

Philippa Briglia
Special Counsel
T +61 3 9611 0174 | M +61 449 404 801
E: pbriglia@sladen.com.au

Jan Harnischmacher
Associate
T +61 3 9611 0158
E joh@sladen.com.au