Payment of Superannuation Death Benefits
The abolition of Reasonable Benefit Limits (RBLs) have certainly made the funding of death benefits through superannuation considerably more attractive. However, without proper planning considerations, many superannuants may see their superannuation benefits significantly reduced by lump sum tax when paid to their adult children.
However when considering superannuation, death benefits and taxes they no longer need to go hand-in-hand. The solution may be as simple as taking advantage of some new rules and applying them in combination with an old strategy.
Simpler Super Legislation
With the introduction of "Simpler Super" (now referred to as "Smarter Super") and a new regulatory regime attention to estate planning issues has become more robust. In particular, the tax implications of superannuation death benefit payments to non-dependant beneficiaries.
To an extent, much of the legislation concerning death benefits has remained the same or very similar to its previous form. However, a few very important changes should prove to be a catalyst for renewed focus in this area. Recent legislative changes include:
- death benefits paid to non-dependants only able to be paid as a lump sum;
- tax free payments from superannuation for people over age 60
- application of the proportional rule to income stream payments; and
- Reasonable Benefit Limits (RBLs) being abolished.
How are death benefit payments taxed in superannuation?
The taxation of death benefits from superannuation will depend on whether the beneficiaries are considered to be dependants or non-dependants and whether the payment is taken as a lump sum or an income stream. If taken as an income stream, the age of both the deceased and the recipient must also be taken into consideration. Special circumstances may apply to income streams received by a child of the deceased.
Is the beneficiary a dependant?
The definition of a dependant differs between superannuation and taxation legislation, with the superannuation legislation allowing a broader definition than the taxation legislation. For the concessional tax treatment to apply to the death benefit payment, the recipient must be considered a ‘death benefits dependant’ under tax law.
For tax purposes, a ‘death benefits dependant’ of the deceased would be:
- the deceased’s spouse or former spouse; or
- anyone that the deceased had an interdependency relationship just before he or she died; or
- the deceased’s child aged less than 18 years; or
- a person who was a financial dependant of the deceased just before he or she died.
Death benefit dependants have the choice of receiving a death benefit payment as a lump sum or an income stream. If received as a lump sum, payments will be tax free to all recipients. If received as an income stream, tax payable will depend on the age of both the deceased and the recipient.
Is the beneficiary a non-dependant?
Anyone who does not satisfy the above criteria for a ‘death benefits dependant’ will be considered a non-dependant. A non-dependant may include:
- adult children, grandchildren, siblings, parents.
As from July 1, 2007, all death benefit payments to a non-dependant beneficiary must be taken as a lump sum.
Of all the legislative changes, it is perhaps this change that has created the increased level of interest in death benefits to non-dependants. While many superannuation benefits may initially be paid directly to a dependant spouse, when that spouse dies most benefits will eventually end up being paid to a non-dependant beneficiary. It is for this reason that advisers should consider the tax implications of death benefit payments made to a non-dependant.
Of all the legislative changes, it is perhaps this change that has created the increased level of interest in death benefits to non-dependants. While many superannuation benefits may initially be paid directly to a dependant spouse, when that spouse dies most benefits will eventually end up being paid to a non-dependant beneficiary. It is for this reason that advisers should consider the tax implications of death benefit payments made to a non-dependant.
Payment to estates
When a death benefit payment is made payable to an estate it will be taxed in the hands of the trustee in the same way as it would have been if paid directly to the person or persons intended to benefit from the estate. The Medicare levy is not payable.
How to maximise death benefits paid to non- dependant beneficiaries?
In many cases, clients no longer have dependant beneficiaries to pass their superannuation entitlements in the event of their death. With many of these clients benefiting from tax free lump sum and income stream payments, they now see maximising their estate as a primary objective when administering their financial affairs.
A simple yet effective solution may be to take advantage of tax free payments from superannuation for people over age 60 and combine a recontribution strategy with the potential benefits of the new proportional rule for income stream payments.
Please note that the following section relates to the payment of benefits from taxed superannuation funds only.
Recontribution strategy
The recontribution strategy is a widely used strategy to assist a client in generating a more tax effective income stream by increasing the tax free component of the superannuation fund. Funds are withdrawn and then recontributed into the superannuation fund as non-concessional contributions to form part of the tax free component. Increasing the tax free component in a superannuation fund also has the additional advantage of providing more tax effective benefits to non-dependant beneficiaries. This is because the tax free component is always tax free regardless of who it is paid to.
Before contemplating a recontribution strategy it is important to check your client’s:
- ability to withdraw from superannuation. Has a condition of release been met?
- tax position before and after implementation. Will tax be payable and if so, how much?
- ability to contribute the proceeds back into superannuation. Can a superannuation contribution be made and how much can be made?
A client’s ability to withdraw will generally come down to whether they have met a condition of release. In most cases, clients under age 55 will not have met a condition of release and are limited in what they can do to maximise their estate. Clients with disability benefits or unrestricted non-preserved monies are exceptions. As a result, this strategy generally targets retired clients in the 55 to 74 age bracket.
For clients under age 60, lump sum tax is still payable on withdrawal which may limit the amount that can be withdrawn tax effectively. This process has taken on more importance since July 1, 2007, as the timeframe to recoup tax costs has effectively been reduced to a maximum five year period, that is, between age 55 and 60.
For clients over age 60, tax free payments from superannuation gives them greater capacity to withdraw funds. However, the real benefit to this strategy lays not with the amount that can be withdrawn, but with the amount that can be recontributed.
An annual contributions cap was introduced on July 1, 2007, limiting the amount of contributions that can be made in a financial year. For the 2007-08 financial year, the annual non-concessional contributions cap is $150,000. Larger contributions can be averaged over a three year period provided the person is under age 65 at any time in the financial year. Once a person reaches age 65 they are limited to the annual cap of $150,000 and the three year averaging provision no longer applies. They are also required to satisfy a work test before being eligible to contribute to super. The work test requires them to be gainfully employed for at least 40 hours during any unbroken 30 day period in that financial year.
Proportional Rule for income stream payments
From July 1, 2007, there has also been a change to the taxation treatment of income stream payments from superannuation. When used in combination with the recontribution strategy, the practical application of this change has the potential to provide significant taxation advantages to clients and their beneficiaries, both dependant and non-dependant.
When an income stream payment is made, the payment will include both tax free and taxable components with the relevant portions of each reflecting the proportions such components make of the total value of fund when the income stream is commenced. This effectively means that if you are able to commence an income stream with funds consisting of 100 per cent tax free component, the income stream will continue to be tax free for the lifetime of the pension. As mentioned previously, the tax free component is always tax free regardless of who it is paid to. Utilising the benefits of this change has the potential to provide tax free benefits to:
- Non-dependant beneficiaries;
- Clients under age 60 receiving an income stream;
- Dependant beneficiaries receiving an income stream when both the recipient and the deceased were under age 60.
Anti-detriment
If paid to a spouse, ex-spouse or child (including adult child), a member’s death benefit from a superannuation fund may be increased to reflect the contributions tax paid in respect of that member between July 1, 1988, and the date of death. This increased payment is often referred to as an ‘anti-detriment’ payment. While the most common formula for this payment has been rewritten to incorporate the new approach to tax components, the principle of the law remains unchanged.
Before implementing a recontribution strategy, careful consideration is required when the death benefit payment may be received by a spouse, ex-spouse or child. Although a recontribution strategy may result in tax free income stream payments to a dependant under age 60, they may also miss out on an anti-detriment payment which is only payable on the non-insurance portion of the taxable component. As the recontribution strategy is designed to reduce the taxable component, it will also reduce the anti-detriment payment.
For example, 56-year-old Ben died on August 1, 2007. He had an eligible service date of January 1, 1990, and a superannuation benefit of $200,000 with no insurance component. He was survived by his wife Betty, also aged 56, who will be paid his death benefit. Ben’s superannuation death benefit payment may be increased by an estimated anti-detriment payment of $35,294. This increase would be far more valuable than the tax savings on an income stream for the four years until Betty reaches age 60.
Summary:
How and to whom superannuation death benefits can be paid is very complex. Before you make provision for the payment of your superannuation death benefits you should seek specialist advice.
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