Re-contribution strategy

How to avoid the Superannuation
Death Tax

WHAT HAPPENS TO YOUR SUPER WHEN YOU DIE

I’ve had people ask me, “Will my family pay tax on my superannuation when I die?” The answer is always the same.

Maybe.

It always comes down to your personal circumstances, and there are a number of different things to consider, but I’d like to share a couple of stories about what I did to help a couple of my clients potentially save over $20,000 each in tax to the beneficiaries of their superannuation.

In the interest of keeping this article brief, if there are any terminology you don’t understand, that’s OK – the financial world contains heaps of terms that aren’t used in everyday conversation – so feel free to reach out and ask if anything doesn’t make sense.

 

IS SUPERANNUATION TAXABLE UPON DEATH

If some of your superannuation is ‘taxable’, which typically happens when it’s been built up from funds paid from your employer, or funds you’ve salary sacrificed (basically, if you don’t personally pay tax on it, it’s probably taxed by the super fund, and is therefore ‘taxable’ superannuation).

Recently I had a couple of clients in very different situations, but they were both concerned about the amount of tax that the beneficiaries might pay when they die. In this instance, it’s important to consider if those nominated to receive the superannuation might be deemed as ‘dependents’ for superannuation and taxation law.

 

WHAT IS A BENEFICIARY AND WHO CAN I NOMINATE TO RECEIVE MY SUPER

A beneficiary is someone you have nominated to receive your superannuation. Under superannuation law, only the following will be recognised as eligible beneficiaries:

          A spouse or de facto spouse

          A child of any age

          A person in a relationship of interdependency

o   This is a close personal relationship between two individuals who live together, where one or both provides for the financial, domestic and personal support of the other – it does not need to be a de facto spouse; it could be a family member or friend where you satisfy these criteria

 

WHAT IS A DEPENDENT FOR TAXATION PURPOSES

Only the following individuals are eligible, under taxation law, to receive your superannuation tax-free upon your death:

          A spouse or de facto spouse

          A former spouse or de facto spouse

          A child under 18 years of age

          A person financially dependent on you

          A person with whom you are in a relationship of interdependency

Under taxation law, a person is included in the definition of a death benefit dependant if they receive a super lump sum because the deceased died in the line of duty. This will be as a member of the defence force, the Australian Federal Police or the police force of a state or territory, or as a protective service officer.

Here’s where things get a bit sticky… If you don’t satisfy the above criteria, the beneficiaries of your estate may end up paying tax when they inherit it upon your death.

 

WHY DOES THIS MATTER

If you don’t have anyone who satisfies the criteria of a dependent under taxation law, they may pay 17% tax (15% + 2% Medicare Levy) on the funds they receive that are ‘taxable’ from your super. You can find out how much of your super would be ‘taxable’ and how much would be ‘tax-free’ by checking your most recent statement or contacting your super fund.

 

HOW TO SAVE BENEFICIARIES FROM THE ‘DEATH TAX’

In the past couple of months, I’ve had two clients who both didn’t have any financial dependents as defined by taxation law. One of these individuals, sadly, had their spouse pass away a couple of years ago. This person has two adult children, both of whom are over the age of 18 and are not financially dependent. The other person I worked with has no spouse, no children and nobody who is financially dependent on them. Based on the criteria outlined above, this means they both have nobody who satisfies the definition of a ‘financial dependent’ under taxation law.

EXAMPLE 1

The first client, let’s refer to this person as Sally, had $142,062 in superannuation. Of these funds, 90.60% were ‘taxable’, meaning that her two adult children would pay 17% tax on $128,712.51. This totals an estimated $21,881.12 in tax that would be payable by her beneficiaries if she were to die tomorrow. That’s 15.4% of her super that would go to the ATO instead of to her children.

EXAMPLE 2

The second client, let’s refer to this person as Barry, had a larger balance. For simplicity’s sake, we’ll round this figure to $650,000. Barry made quite a lot of voluntary contributions after he’d paid tax personally, so there was quite a lot more super that was tax-free. In fact, the total amount that was taxable was 51.87% ($337,155) of the total balance.

If Barry was to die tomorrow, at a rate of 17% on the $337,155, the beneficiaries of Barry’s superannuation would pay $57,316.35 in tax because they aren’t ‘financial dependents’ under taxation law. This means the $650,000 would actually turn into $592,683.65.

 

WHAT DID WE DO TO REDUCE THIS

There are a number of ways to reduce the taxable component of your super. You could increase your after-tax contributions, for example, or you could do a ‘re-contribution strategy’ if you are aged over 60 and have retired, or over 65 and still ‘gainfully employed’ (working 40 or more hours in a 30 day period during the financial year). Other circumstances exist where you might be able to do this, but let’s generalise these for the purpose of simplicity.

 

WHAT IS A ‘RE-CONTRIBUTION STRATEGY’

Remember, in order to reduce the amount that is taxable to your non-financial dependents (for tax purposes), we need to decrease the ‘taxable’ component and increase the ‘tax-free’ component.

For Client 1, Sally, as she is over 60 (but under 65) and retired, we withdrew her entire superannuation balance, created a new superannuation account, and funded it with money from the bank. The new fund would deem these contributions as ‘after tax’ (or ‘non-concessional’, for the fancy terms) and so 100% of the balance would now be tax-free to her dependents.

This is a $21,881.12 tax saving.

For Client 2, Barry, he is also over 60 (but under 65) and retired. We withdrew $300,000 from his superannuation balance and then re-contributed / transferred it back into his super fund. You are normally only allowed to make $100,000 per year in non-concessional contributions, but you may be able to use the ‘bring-forward rule’ to contribute in advance for the following 2 years, meaning you can contribute up to the cap for the next 3 years ($100,000 x 3 = $300,000).

As 100% of the funds Barry re-contributed back into his super fund were tax-free, this adjusted the amount that was ‘taxable’ and how much was now ‘tax-free’. The taxable component was originally 51.87% of the balance but was now 27.93% taxable. This means that the beneficiaries of Barry’s estate would now only need to pay $30,862.65 in tax.

This is a $26,453.70 tax saving.

The information in this article is not financial advice and should not be misconstrued as such. This article has not covered every element that may need to be considered when doing a re-contribution strategy, and I do not recommend you undertake this strategy without professional financial advice to confirm its suitability.

You should consider who is a suitable beneficiary, whether this strategy could work for you, or whether there may be other things you can do to better manage your superannuation and estate plan.

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