Taxation of death benefits


October 21, 2021

The Australian taxation system is generally considered to be complicated. Taxation on superannuation certainly has not escaped that complex web. In trying not to overload the readers, this article will only focus on taxation of superannuation death benefits (death benefits).

The Australian taxation system is generally considered to be complicated.  Taxation on superannuation certainly has not escaped that complex web.  In trying not to overload the readers, this article will only focus on taxation of superannuation death benefits (death benefits). 

Before going through the tax treatment of death benefits, some key concepts need to be explained first.

What is a superannuation benefit?

Superannuation benefits are typically paid from superannuation funds, Retirement Savings Accounts, approved deposit funds or superannuation annuities. 

What are the types of superannuation benefits?

A superannuation benefit can be paid as either a superannuation member benefit (member benefit) or a superannuation death benefit (death benefit) (s307-5 Income Tax Assessment Act 1997 (ITAA 1997)).  A superannuation benefit can be paid as either a lump sum (s307-65 ITAA 1997) or as an income stream (s307-70 ITAA 1997).

A member benefit is the benefit paid to the member or another person as requested by the member during the member’s lifetime.  A death benefit is paid as a result of the death of the member.

What are the components of a superannuation benefit?

A superannuation benefit comprises two components:-

Tax free component

A tax free component of a superannuation interest is the total value of the ‘contributions segment’ and the ‘crystallised segment’. 

Without going to the technical meaning of those terms, the tax free component of a superannuation benefit is generally made up of contributions from a person’s post-tax income and by amounts which represent the portion of a superannuation benefit that accrued before 1 July 1983. 

The tax free component is as its name suggests – tax free.

Taxable component

The taxable component of a superannuation benefit is the total value of the superannuation benefit less the tax free component (s307-215 ITAA 1997).  The taxable component of a superannuation benefit paid from a superannuation interest consists of 2 elements (s307-275 ITAA 1997):-

For most people, the taxable component is entirely made up of an element taxed in the fund, i.e. a part that has been subject to tax at the time that contributions were made & upon earnings.z

An element untaxed in the fund usually arises in public sector superannuation plans where tax has not been paid on contributions or earnings, or from unfunded schemes.

Relevant legislation

Before we get into how death benefits are taxed, it is important to mention that there are two key pieces of legislation involved when dealing with superannuation benefits.  The law that governs superannuation funds is set out in the Superannuation Industry (Supervision) Act 1993 (SIS Act); whereas the law that sets out how death benefits are taxed is in the Income Tax Assessment Act 1997 (ITAA 1997). 

When discussing death benefits, the term ‘dependant’ is referred to frequently.  It is important to note that the definition of ‘dependant’ in the SIS Act includes adult children and is wider than the definition of ‘death benefits dependant’ (DB dependant) in s302-195 ITAA 1997.  This is important to keep in mind when determining whether a ‘dependant’ will receive a death benefit tax-free.

As most of you know, superannuation does not automatically form part of your estate (Stock (as Executor of the Will of Mandie, Deceased) v N.M. Superannuation Proprietary Limited [2015] FCA 612).  This is because the legal owner of the superannuation is the trustee of the superannuation fund.  The member is the beneficial owner.

Taxation of superannuation death benefits

Division 302 of the ITAA 1997 sets out the tax treatment of death benefits. 

To determine the tax consequence of the beneficiary, the following questions need to be asked:-

Once you have answers to the above questions, you will get closer to work out the tax rate using the flow chart. 

In summary:

Lump sum death benefit

A lump sum death benefit payment paid to a DB dependant is tax-free.

Income stream death benefit

Income streams can only be paid to a DB dependant of the deceased.

Where death benefit is paid to the estate

Death benefits can be paid to estates rather than to an individual if the trust deed of the superannuation fund allows it and the member has made such a nomination in their binding death benefit nomination (BDBN).  A BDBN requires the trustee of the superannuation fund to pay a death benefit to the member’s dependants or legal personal representative (LPR) (s59 SIS Act).  Having a death benefit paid to an estate is desirable if:-

Tax planning

As discussed so far, death benefit consisting of taxable component will likely result in tax payable.  One way to tax plan is for the member to cash-out the benefit before the member’s death if the member is 60 years old or over.  This is because such superannuation benefit paid to a member is tax free during the member’s life. 

Alternatively, the member can direct tax-free component to adult children in the member’s will to allow the adult children to inherit the death benefit as a lump sum tax free.

When preparing a will or making a BDBN, it is therefore important to keep in mind which beneficiary can best take advantage of the tax free consequences when receiving death benefit and plan accordingly. 

Christina Fung, Adelta Legal

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