Unpleasant shocks with SMSF death taxes

Who doesn’t have to pay the super death tax?

Superannuation death benefits are received tax-free by recipients who count as tax dependants (except for special cases such as where the deceased and the recipient are both under 60 and the recipient receives the benefits as a pension). Any of the following four categories counts as a tax dependant:

• Your spouse (including de facto) or former spouse;
• Your child aged under 18 years old;
• Any person who you have an interdependency relationship just before you died; and
• Any person who was financially dependent on you just before you died.

Accordingly, when leaving all super directly to your spouse as a lump sum or pension, the spouse will receive it all tax-free, apart from in some special cases.

While your children of any age are always allowed to directly receive your super death benefit, the children will not always qualify as tax dependants, and, as such, may be liable to tax. In fact, the most common category of persons who don’t qualify as tax dependants are your children who are aged 18 or over, unless they are in an interdependency relationship with you or are financially dependent on you. Both of these are typically hard to prove.

The ATO has historically placed a very high hurdle to prove financial dependency, and it often applies the following test:

If the financial support received by a person were withdrawn, would the person be able to survive on a day-to-day basis? If the financial support provided merely supplements the person's income and represents 'quality of life' payments, then it would not be considered a substantial support. What needs to be determined is whether or not the person would be able to meet the person's daily needs and basic necessities without the additional financial support.

Similarly, the law places a high standard for an interdependency relationship, which requires all of these factors to be met for two people:

• they have a close personal relationship (the ATO has a high standard to prove this);
• they live together;
• one or each of them provides the other with financial support; and
• one or each of them provides the other with domestic support and personal care. 

If a person doesn’t meet any of the four tests to be a tax dependant, tax may apply when they receive a super death benefit.

How much is the death tax?

For a non-tax dependant who receives a super death benefit, the money leaving the fund is broadly comprised of two components: tax-free component and taxable component. The tax-free component is broadly the money in your fund that was put there by your after tax non-concessional contributions. The recipient takes this tax-free component ‘tax free’ without paying any income tax. On the other hand, the taxable component is broadly money in the fund that was put there by contributions such as employer contributions plus earnings. The recipient of the taxable component will usually pay at most 15 per cent tax plus levies on that component, unless special situations apply to lift the rate to 30% plus levies. However, if the recipient has low to nil taxable income in that financial year, their tax-free threshold may apply.

When a legal personal representative (estate) receives a super lump sum, the tax law applies as if the recipients under the will received the death benefits directly, except that the legal personal representative pays the tax on behalf of the recipients. Some advantages of paying death benefits to the estate is that the Medicare levy does not apply, and the money can be dealt with in a more sophisticated or strategic way through the will. One disadvantage is that the money sent to the will might be subject to a family provision claim (i.e., a challenge to the will).

Why some do not pay the super death tax

The ‘super death tax’ only applies when a person dies with money in superannuation. Those who have met a full condition of release and withdraw super prior to dying but after reaching age 60, will be able to take those withdrawals into their hands tax-free. At this point, if desired, it is possible to then gift money or assets to people, or leave this in your will.

Are there any other effective super death taxes?

In addition to the above, there are other imposts on the death of a super fund member. Until mid-2017, those with a surviving spouse were used to the idea that their benefits could be paid to the surviving spouse by way of pension, which typically allowed non-liquid assets such as real estate to remain in the super fund environment. However, since 1 July 2017, death benefit pensions count toward to the surviving spouse’s $1.6 million transfer balance cap, which is a cap on how much a person can transfer into retirement phase (i.e., full pension phase). This limit may now force benefits to come out as a lump sum to the surviving spouse because the law still requires super to be paid out as soon as practicable after a person’s death. When this occurs as a lump sum and an asset such as real estate needs to be transferred out, this triggers a CGT event for the super fund. For land such as New South Wales real estate, stamp duty may apply on this transfer. This may come as an unpleasant shock.

Accordingly, while there is no headline ‘death tax’ as such, the death of a super fund member can often give rise to tax and duty. Naturally, appropriate advance planning and ensuring a well-documented succession plan is in place can minimise any death tax.

By David Oon, senior associate, DBA Lawyers