Tax on super death benefits: a worked example for adult children and other non-dependants

A superannuation lump sum death benefit is tax-free if it goes to a death benefits dependant: a spouse or former spouse, a child under 18, someone in an interdependency relationship with the deceased, or anyone else who was financially dependent on them (Income Tax Assessment Act 1997, s 302-195). Paid to anyone else, most often an adult, independent child, the taxable component is assessable and taxed at no more than 15% on the taxed element and 30% on the untaxed element (s 302-145). If the fund pays the beneficiary directly, the Medicare levy (generally 2%) is added, so the usual rates are 17% and 32%. The tax-free component is never taxed. Example (illustrative): a $240,000 taxed element paid directly to an adult son costs $40,800 in tax.

The super death benefit tax estimator runs this calculation. This guide is general information, not tax advice.

Step 1: who is receiving the benefit

Two different definitions matter, which confuses many families.

So an adult child can receive a death benefit directly, because every child is a SIS dependant, but is usually taxed on it, because an independent adult child is not a death benefits dependant for tax.

Step 2: the components

The fund splits each benefit into:

• Tax-free component: broadly, non-concessional (after-tax) contributions and certain other amounts. Never taxed.
• Taxable component – taxed element: money on which the fund has paid tax, such as employer and salary-sacrifice contributions and earnings. Maximum 15% for a non-dependant.
• Taxable component – untaxed element: arises mainly in some public sector schemes and when a fund pays out insurance proceeds and claims deductions for premiums. Maximum 30% for a non-dependant.

Ask the fund for the component breakdown. The deceased's last member statement gives a guide but is not final.

Step 3: direct payment or through the estate

Paying through the estate can save the 2% Medicare levy for non-dependant beneficiaries, but it exposes the money to creditors and claims, and delays payment. Weigh both.

Worked example 1: adult son, paid directly (illustrative)

Margaret, 74, dies with $300,000 in her account-based pension. The fund reports a tax-free component of $60,000 and a taxed element of $240,000. Her binding nomination names her son David, 46, who is financially independent.

1. Tax-free component: $60,000 × 0% = $0
2. Taxed element: $240,000 × 15% = $36,000
3. Medicare levy: $240,000 × 2% = $4,800
4. Total tax: $40,800. David receives $259,200.

Worked example 2: same benefit through the estate (illustrative)

If the nomination had been to Margaret's legal personal representative and her will left everything to David:

1. Tax on the taxed element: $240,000 × 15% = $36,000 (no Medicare levy)
2. Saving: $4,800 compared with direct payment
3. Trade-off: the benefit is now part of the estate. A family provision claim by another family member could reach it, and distribution waits for probate.

Worked example 3: insurance creates an untaxed element (illustrative)

Ben, 41, dies with $90,000 of super and a $400,000 life cover payout inside the fund. The fund's calculation produces a taxed element of $150,000 and an untaxed element of $340,000. If it is paid directly to his financially independent daughter, 21 (a SIS dependant the fund can pay, but not a death benefits dependant for tax):

• Taxed element: $150,000 × 17% = $25,500
• Untaxed element: $340,000 × 32% = $108,800
• Total: $134,300

Paid to his de facto partner instead, the whole $490,000 would be tax-free. This is why the choice of beneficiary, and evidence of dependency or an interdependency relationship, matters so much.

Reversionary pensions and dependants

A spouse can usually continue receiving a pension (a reversionary or death benefit income stream). A child can receive a death benefit pension only in limited cases: generally if under 18, under 25 and financially dependent, or permanently disabled, and the pension must usually be commuted to a lump sum when the child turns 25 unless disabled. Income streams interact with the transfer balance cap, so check with the fund or an adviser.

Planning ideas and their limits

• Withdrawals before death: a member over 60 who has met a condition of release can generally withdraw super tax-free. Some families withdraw when death is near to avoid the death benefit tax, but timing, capacity, the attorney's authority and the risk of acting too late all matter. Get advice.
• Recontribution strategies can convert taxable component into tax-free component while the member is alive and eligible to contribute. These are subject to contribution caps and age rules.
• Binding nominations decide who receives the money; they do not change the tax.

FAQ

Is a death benefit to my adult daughter taxed if she lived with me?

Only if she qualifies as a financial dependant or had an interdependency relationship with you. Living together alone is not enough; the trustee and the ATO look at financial support and care.

Does the tax depend on my child's other income?

The lump sum is assessable, but the tax offset caps the rate on each element at the maximum rate. The amount is included in their tax return, so the fund's withholding is credited.

Does a will decide who gets my super?

Only if the super is paid to your estate. Otherwise the fund decides, guided by any valid nomination and the trust deed.

Sources

• Federal Register of Legislation — Income Tax Assessment Act 1997, ss 302-145, 302-195 and 302-200; SIS Act 1993 and Regulations
• Australian Taxation Office — super death benefits, components and the Medicare levy
• Australian Financial Complaints Authority — complaints about death benefit decisions
• Related: lapsed binding nominations, CGT on inherited property, checklist, family provision