Q&A – Gifting an inheritance to a minor - is it tax effective?

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Gifting an inheritance to a minor  is it tax effective?


By Stuart Sheary, Senior Technical Manager

Q: A new client's spouse has recently passed away. The deceased spouse had a life insurance policy of $3,000,000 and super of $1,000,000. The beneficiary of the life policy is the surviving spouse and there is a binding death benefit nomination to the surviving spouse relating to the deceased's super benefits.

The deceased and the spouse have a minor child and the surviving spouse would like to invest an amount in the child's name using either the super death benefit or part of the proceeds from the life insurance policy. 

Can this be done tax effectively?

A: Unearned income of a minor is typically taxed at penalty tax rates This unearned income may be in the form of dividends, interest, but excludes income 'earned' by the minor such as employment income. 

The following table applies to unearned income of a minor in the 2021/2022 financial year.

 Eligible taxable income Tax payable 
 $0 - $416  Nil
 $417 - $1,307  66% of each dollar exceeding $416
 $1,308 +  45% of each $1 that is not excepted income

Tax treatment of direct insurance, super or estate proceeds received by the minor child

Under ITAA 1936 s102AE (2)(b) (iv) & (v) income from an insurance or super death benefit paid directly to support a minor is treated as excepted income to a minor and therefore taxed at adult marginal rates. Income on assets inherited directly from a deceased estate is also taxed at adult marginal tax rates per s102AE (2) (c) (i). The child's tax liability may be minimal if it falls within the tax-free threshold or lower tax bracket.

Testamentary source or not?

In the gifting scenario, as both the insurance and super were paid directly to the spouse and not to either the deceased's estate or child, the provisions of s102AE (iv) and (v) are not satisfied. The proceeds paid to the surviving spouse were from a testamentary source but as the proceeds are 'gifted' by the surviving parent to the child, earnings will be taxed at higher penalty tax rates per the table above.

Again, had the insurance or super been paid directly to the child, the earnings on the inheritance would be taxed at adult tax rates.

Alternatively had the insurance or super been paid to the estate it may be possible to invest in the minor child's name without earnings being subject to penalty tax rates by using an estate proceeds trust or a superannuation proceeds trust with the child as beneficiary.

Minor child beneficiary of estate

Under s102AE(2) (c ) (i) if the child receives an amount as a beneficiary of the estate, income earnings on the proceeds will be taxed at adult tax rates.

A super proceeds trust may also be established if set out in the Will prior to the deceased's passing. Income distributions from a super proceeds trust are also taxed at adult tax rates s102AG(2)(c )(v)

If a super proceeds trust is not set out in the Will but the deceased's super fund trustee agrees, a super death benefit may be paid directly to the super proceeds trust. The super proceeds trust would need to be created on behalf of the child prior to payment of the super death benefit. 

As there is a binding nomination in favour of your client as surviving spouse a super proceeds trust is not an option in this case.

Estate proceeds trust

If the minor child is not a beneficiary of the estate, a person who is a beneficiary of the deceased estate can establish an estate proceeds trust under s102AG(2)(d)(ii) for the child's benefit using part of their inheritance. Income from an estate proceeds trust is not subject to higher penalty child tax rates. The maximum amount that may be transferred into the estate proceeds trust is limited to the amount the child would have received had the deceased died intestate under s102AE (10) and s102AG (7). The estate proceeds trust must be established within three years of the passing of the deceased.

Note establishing an estate proceeds trust may be limited in some states due to their intestacy laws. 

As there is a binding nomination in favour of your client as surviving spouse an estate proceeds trust is not an option in this case.

Importance of planning

With a variety of possible options, this example reflects the importance of thorough estate planning to pass on inheritance to family members in a more tax effective way. 

More information

If you have any questions, or would like more information, please contact the IOOF TechConnect team on 1300 650 414.

The information in this section of the website is intended for financial advisers only and is not to be distributed to clients. It has been prepared on behalf of Australian Executor Trustees Limited ABN 84 007 869 794 AFSL 240023, IOOF Investment Management Limited ABN 53 006 695 021 AFSL 230524, IOOF Investment Services Ltd ABN 80 007 350 405, AFSL 230703 and IOOF Ltd ABN 21 087 649 625 AFSL 230522 based on information that is believed to be accurate and reliable at the time of publication.