Superannuation is one of the most tax-effective ways to save for retirement in Australia, but it’s important to consider how your superannuation will be treated after you pass away. One key consideration is the death benefits tax that may be payable if your superannuation is paid to non-tax dependent beneficiaries, such as adult children. Fortunately, strategies such as the withdrawal and re-contribution strategy can help reduce or even eliminate this tax, ensuring more of your hard-earned savings go to your loved ones. In this blog post, we’ll explore how death benefits tax works, why non-tax dependent beneficiaries may face higher tax bills, and how a withdrawal and re-contribution strategy can reduce the tax burden.
Understanding Death Benefits Tax on Superannuation
When a superannuation balance is paid out as a death benefit after someone passes away, the tax treatment of that payment depends on two key factors:
- The relationship between the deceased and the beneficiary, and
- The components of the superannuation balance (taxable vs. tax-free).
Tax-Dependent vs. Non-Tax Dependent Beneficiaries
- Tax-Dependent Beneficiaries: These include a spouse, children under 18, a person financially dependent on the deceased, or someone in an interdependent relationship with the deceased. Payments made to tax dependents are generally tax-free.
- Non-Tax Dependent Beneficiaries: These are typically adult children (over 18) or other relatives who do not qualify as tax dependents. When death benefits are paid to non-tax dependents, part of the benefit may be subject to tax.
Tax on the Taxable Component of Superannuation
Superannuation balances are generally made up of two components:
- Tax-Free Component: Includes non-concessional contributions (after-tax contributions). This part of the super balance is always tax-free when paid as a death benefit.
- Taxable Component: Includes concessional contributions (before-tax contributions) and any earnings on those contributions. This is the part that can attract tax when paid to non-tax dependents.
For non-tax dependents, the taxable component of a superannuation death benefit is subject to the following tax rates:
- Up to 15% plus Medicare Levy (2%) on the taxable taxed element.
- Up to 30% plus Medicare Levy (2%) on the taxable untaxed element (this typically applies to untaxed super funds).
The Impact of Death Benefits Tax on Non-Tax Dependents
Let’s say you’ve accumulated a significant superannuation balance that you plan to leave to your adult children. If your balance is primarily made up of concessional (taxable) contributions, a significant portion of the balance could be taxed before it reaches your children. For example, if your superannuation includes $500,000 in the taxable component, up to 17% (15% plus the 2% Medicare Levy) could be taxed, meaning your beneficiaries could lose $85,000 in tax.
There are strategies you can use to reduce the amount of tax payable by non-tax dependent beneficiaries. One of the most effective is the withdrawal and re-contribution strategy.
What is a Withdrawal and Re-Contribution Strategy?
A withdrawal and re-contribution strategy involves withdrawing a portion of your superannuation while you are still alive and then recontributing the amount back into your super as a non-concessional contribution. This strategy converts the taxable component of your super into the tax-free component, which is not subject to death benefits tax.
How the Strategy Works:
- Withdraw Super: You withdraw some or all of your superannuation balance once you’ve reached preservation age (usually 60 years old and retired, or 65 regardless of work status). If you’re over 60, withdrawals are tax-free.
- Re-Contribute as Non-Concessional Contributions: You re-contribute the withdrawn funds back into your super as non-concessional (after-tax) contributions. These contributions form part of the tax-free component of your superannuation.
Annual Contribution Caps:
- Non-concessional contributions are capped at $120,000 per year. However, if you’re under 75, you may be able to use the bring-forward rule, which allows you to contribute up to three years’ worth of non-concessional contributions in one go, meaning you could contribute up to $360,000 at once.
- It’s important to note that your total superannuation balance must be below $1.9 million to make non-concessional contributions.
Key Considerations for the Withdrawal and Re-Contribution Strategy
While this strategy can offer significant tax benefits, there are a few important considerations:
- Superannuation Caps: Make sure you stay within the non-concessional contribution caps. If you exceed these caps, you may face tax penalties.
- Total Super Balance: You can only make non-concessional contributions if your total superannuation balance is below $1.9 million at the start of the financial year.
- Preservation Age: You can only access your super once you meet a condition of release, such as retirement. Once you turn 65, you can access your super without restriction.
- Timing: The earlier you implement this strategy, the more tax-free component you can build up over time. This can be especially beneficial if you plan to leave a large super balance to adult children or other non-tax dependent beneficiaries.
Final Thoughts
Death benefits tax on superannuation can significantly reduce the inheritance you leave to non-tax dependent beneficiaries, but with a little planning, this tax can be reduced or avoided. A withdrawal and re-contribution strategy is an effective way to convert the taxable component of your super into a tax-free component, ensuring more of your hard-earned savings go to your loved ones.
As with any financial strategy, it’s essential to consult a financial advisor to ensure this approach is suitable for your specific circumstances and that you’re adhering to the contribution caps and tax rules.
If you’d like to explore whether a withdrawal and re-contribution strategy could work for you, contact our team of experienced Financial Advisors today. We’ll help you develop a plan that maximises the benefits for you and your beneficiaries.
