Cutting the Super Death Benefits Tax

The superannuation rules were changed on 1st July to allow anyone under age 75 to make non-tax-deductible contributions to their super without meeting the work test. They can be retired and still contribute. This provides an opportunity to cut the death benefits tax on their super.

Pension income payments and lump sum withdrawals received by retirees during their lifetime are entirely tax free. However that changes on death. It isn’t well known that most super benefits will incur significant tax costs when paid to beneficiaries.

Benefits can be paid to spouses and minor dependents (children under age 18) tax free. In most cases payments to others, including adult children, will be partly or wholly taxable.

In the past little could be done about this after retirement. Now it can be, for those under age 75 at least. Super account balances are made up of a taxable component and a tax-free component. Most balances built up through employment have a very large taxable component.

On death the taxable component is usually taxed at 15 per cent plus Medicare Levy, 17 per cent in total. If the taxable component is say $300,000 the tax will be $51,000. That’s a nice amount to avoid if possible.

This tax can be greatly reduced using the new rule. Anyone over age 65, or 60 if retired, can draw lump sums out of their super fully tax-free. Withdrawals come out of the taxable and tax-free components in proportion. Contributions without claiming a tax deduction go fully into the tax-free component.

So, by taking money out of a super account and then putting it back in again, money is moved from the taxable component into the tax-free component. When the retiree passes away their beneficiaries will pay no tax on the tax-free component of the benefit they receive.

Contribution limits must be complied with. The annual non-tax-deductible limit is $110,000. However people are allowed to bring forward two future years’ contributions so long as no further amounts are put in within three years. This allows a single amount of up to $330,000 to be contributed to super.

For people with a large taxable component in their super account it will therefore make sense to withdraw $330,000 from their account and then recontribute it back into their fund, or another one, immediately.

People who are more than three years from age 75 will have the opportunity to undertake the withdrawal and recontribution strategy more than once before they reach that age. They could do it twice, or in some cases, three times. This will eliminate most, or all, of the future death benefits tax.