Minimising super death tax

There are strategies to ensure your children get the maximum benefits

Many baby boomers have accumulated big balances over the 2½ decades since super’s inception. Their super may be approaching, or even exceed, the value of the family home. But unlike the home, which is free of death taxes, super’s 17% death tax applies to adult children.

There are, however, strategies to reduce its impact. But first you need to understand which beneficiaries will be taxed, how they will be taxed and what you can do about it.

Basically, no tax is payable on death benefits given to a spouse, de facto, same-sex partner, someone financially dependent on you, a child under 18 (or older if a financially dependent student), or someone you have an interdependency relationship with. The rest get taxed.

“All your money going into super is broken down into a taxable component and a tax-free component,” says Colin Lewis, head of strategic advice at Perpetual Private. “Your taxable component is made up of all your pre-tax contributions: your employer’s super guarantee, any salary sacrifice you make, or any contribution you have claimed a tax deduction on. All the earnings in the fund form the taxable component.

“The only portion that is tax free is your after-tax non-concessional contributions. So when we are talking about how much death benefit tax applies, it’s on everything in the fund other than your non-concessional contributions.”

Tax payable on the taxable component is at a rate of 15% plus the 2% Medicare levy. Lewis says even if the benefit is paid through the deceased’s estate, the adult son or daughter are still subject to the death tax but not the 2% Medicare levy.

One common strategy to minimise the tax is to withdraw an amount from super and recontribute it as a non-concessional contribution. By doing this you are converting the taxable component into a tax-free component. But the rules are complex.

Generally, once you are 60 and retired (it doesn’t have to be permanently) you can access your super tax free. At 65 and over, retirement isn’t a requirement but to be eligible to make contributions you must meet a work test.

Laura Menschik, a certified financial planner and director of WLM Financial Services says: “Let’s say I’m over 65, I’m still earning a reasonable income, I could draw out $100,000 and recontribute that back as a non-concessional contribution and it goes in tax free. That’s one way of reducing the taxable component.”

The non-concessional contribution could also be made to your spouse’s account, especially if you are close to exceeding the $1.6 million super cap. “It might be a strate- gic plan to even out both balances,” says Menschik.

It all comes down to whether you’re eligible to take out a lump sum and then whether you are eligible to recontribute it, says Lewis. “You have to be mindful, first of all, if you are eligible to recontribute, that is, put the money back into super – you are under 65, or over 65 and meet the work test. And secondly, how much can you put back in. You’ve now got to be careful of lower non-concessional contribution caps, which have dropped from $180,000 to $100,000.

“People who have over $1.6 million in super are also no longer able to do the recontribution strategy. If your total super balance is $1.6 million or more, then you can’t make an after-tax contribution to super,” says Lewis.

Other strategies involve pulling money out of super. “If a person has an injury or illness, it might be a heart attack and they are towards the end of their life, the best strategy for a whole host of reasons is to sell down the portfolio and transfer all the benefits out of super to their personal bank account. It’s then paid out to the beneficiaries as per the distribution of their will and there is no tax,” says Menschik.

Or you could leave everything to your spouse. “From a tax viewpoint if you’ve got a spouse and adult kids and you want them all to benefit, you’re better off giving it to your spouse and letting them pay it out tax free,” says Lewis. “The issue comes when you’ve got blended families. Can you trust your spouse to pay whatever you wished for the children of your former relationship?”

And if you don’t have a huge amount in super it might be simplest to withdraw it. Lewis says a couple over 65, qualifying for the senior and pensioner tax offset, can earn $28,974 a year each tax free. See table.

Given the complexity of the rules, it’s vital you get professional advice first.