Future Focus: Who gets your super?
And how much tax they’ll pay.
Superannuation is one of the largest assets that most people hold. It pays to be aware of what happens to it if you die.
Unlike other assets, superannuation isn’t automatically covered by your will. The tax treatment can vary dramatically depending on who your beneficiaries are. Your nominations matter and must be carefully considered – it could mean costing your loved ones thousands of dollars in tax.
It is important to understand how superannuation death benefits work, the different types of beneficiaries you can nominate and how tax will change the final outcome.
Why super isn’t included with your other assets
The disposal of most of your assets are dictated by your will when you die. They form part of your estate and are distributed according to your wishes, or state law if you do not have a valid will.
Superannuation is treated separately because it is held in a trust structure. Your super fund’s trustee is bound by superannuation rules that designate how to distribute assets. . The trustee will turn to your beneficiary nomination to understand your wishes. If there’s no valid nomination, the trustee will decide where your superannuation benefit goes. This may be paid to your estate or to dependants, depending on the circumstances.
Who can receive your superannuation
There are conflicting definitions of what a dependant is when it comes to superannuation and tax law.
Superannuation is governed by the SIS Act which states a ‘dependant, in relation to a person, includes the spouse of the person, any child of the person and any person with whom the person has an interdependency relationship.’
This means that a valid dependant can be a spouse (not former), a child, or any person that has an interdependent relationship.
A tax dependant in relation to death benefits is a little different.
s302-195 (1): A death benefits dependant, of a person who has died, is (a) the deceased person’s spouse or former spouse; or (b) the deceased person’s child, aged less than 18, or (c) any other person with whom the deceased person had an interdependency relationship under section 302-200 just before he or she died, or (d) any other person who was a dependant of the deceased person just before he or she died.
A spouse or former spouse, any children under 18, and any financial dependants would be eligible for preferential tax treatment.
In short, any adult children would not be categorised as a tax dependant and would face different tax treatment.
How a superannuation lump sum will be taxed
How a superannuation lump sum and income stream will be taxed depends on the tax components.
- Taxable (taxed) is when you have paid 15% tax on contributions and earnings.
- Taxable untaxed is when the fund has not paid any tax on the contributions or earnings. These are usually public sector schemes.
- Tax-free includes contributions where a tax deduction has not been claimed by the member (non-concessional contributions).
How a superannuation income stream will be taxed
The difference between tax status
Imagine Sally dies at 65 with $800,000 in super, made up of 80% taxable (taxed) and 20% tax-free components.
In this example, James receives $48,000 less because he is not a tax dependant. If Sally had directed her super to her estate, the tax outcomes would have been identical. Tax treatment follows the end beneficiary and not the estate.
Binding vs non-binding nominations
There are two main types of nominations for superannuation – binding and non-binding.
Binding nominations are a legally valid nomination to a valid dependant. Binding nominations can be lapsing, or non-lapsing. Non-lapsing is valid until death. Lapsing is the most common which expires every three years to protect from changing circumstances.
For example, you might make a nomination for a spouse. Twenty years later you might have children, you might be remarried, you might be divorced – there’s a range of possibilities over the decades that you have super. A lapsing nomination expires to account for that. Once it does lapse, if it’s not renewed it turns into a non-binding nomination. This is a strong suggestion as to where a death benefit should be paid. The trustees of the superannuation fund will take current circumstances into account.
Reversionary beneficiary
Distribution of estates can be a messy, complicated and a drawn-out affair. Reversionary beneficiaries are important if there is a loved one that is financially dependent (or interdependent) on the income stream coming from a pension account. Upon death, a reversionary beneficiary will receive the income stream payments without delay. This provides protection from the decision going to the superannuation trustees and requiring more paperwork (and time).
The amount that is contributed to the reversionary beneficiary will count towards the Transfer Balance Cap and must duplicate the original tax components of the deceased person’s account.
Insurance inside super
Some Australians hold life insurance through their superfund. When you die, the insurance payout is paid into your account and it forms part of your death benefit.
For tax dependants, the whole amount is tax-free as a lump sum. For non-tax dependants, the proportioning rule is used. This means that the death benefit is proportioned to the same amounts in each classification in the superfund. For example, if the super account is 80% taxable and 20% tax-free, the death benefit will be classified in the same way.
If your intended beneficiary is a non-dependant, like an adult child, it may be worth considering insurance outside of super where there will be no tax at death.
Optimise your super for estate planning
- Use withdrawals and recontributions
My colleague Simonelle Mody has written on how to reduce the taxable proportion of your super account. You are able to withdraw super (tax-free after 60) and recontribute it as a non-concessional contribution. This moves more of your super into the tax-free component and can reduce tax for non-dependant beneficiaries.
- Review your insurance
If your intended beneficiary is not a tax dependant, it may be worth considering retail life insurance policies to avoid a higher tax, keeping in mind that you are paying premiums for a retail policy with after-tax funds.
- Keep your nominations current
Ensure that your beneficiary nominations reflect your wishes, as circumstances can always change.
- Consider financial dependency for adult children
If you have an adult child that lives with you and relies on you for support, this may qualify as financially dependent, changing the tax treatment. Documentation will be required to support this.
Final thoughts
Not all beneficiaries are treated equal for tax purposes. Ensure that you have structured your superannuation, mindful that is governed by different rules than the rest of your estate. Doing so can mean tens of thousands of dollars saved in tax by your loved ones upon your death.
Invest Your Way
For the past five years, Mark and I have released a weekly podcast and written on morningstar.com.au to arm you with the tools to invest successfully. We’ve always strived to provide independent, thoughtful analysis, backed by the work of hundreds of researchers and professionals at Morningstar.
We’ve shared our journeys with you, and you’ve shared back. We’ve listened to what you’re after and created a companion for your investing journey – Invest Your Way. Invest Your Way is a book that focuses on the investor, instead of the investments. It is a guide to successful investing, with actionable insights and practical applications.
If anyone would like to support this project you can buy the book at the below links. It is also available in Kindle and Audiobook versions. Thanks in advance!
