Super death benefit lump sums: Who should be nominated to achieve a better outcome?

By Janet Manzanero-Caruana, Senior Technical Manager

Should super death benefits be paid directly to a non-tax dependant or through the deceased person’s estate?

You should discuss your client’s super death benefit nominations with them and consider the beneficiaries’ individual situations.

Super death benefits can be paid directly as lump sums to your deceased client’s dependants for super purposes (superannuation dependant) or their legal personal representative (LPR) under a binding nomination, at trustee’s discretion or in accordance with the super fund’s trust deed. The LPR is the executor of the deceased’s estate or the administrator of the estate if the deceased died intestate. If paid to the deceased’s LPR, the death benefit lump sum becomes part of the deceased estate which is distributed to beneficiaries, including those who are not superannuation dependants.

Superannuation dependants may not be dependants for tax purposes (tax dependants). Super death benefit lump sums paid to tax dependants are paid tax free.

Individuals who are not tax dependants receive the tax free component of the lump sum tax free but are assessed on the taxable component.

When recommending whether super death benefit lump sums be paid directly or indirectly via the LPR to non-tax dependants, you should consider asset protection, the impact this could have on their tax positions and on any income tested concessions they have.

Who can receive super death benefits directly?

Generally the super fund trustee can pay death benefits only to superannuation dependants and the LPR. Superannuation dependants include:

Spouse
child (includes adopted child, step-child or ex-nuptial child, or a child born from artificial conception or a surrogacy arrangement)
a person who is financially dependent on the deceased at the time of death
a person who had an interdependency relationship with the deceased at the time of death.

The trustee may pay death benefits to another person only if the trustee has not found any superannuation dependant or the LPR of the deceased.

Non-dependant (adult) children are superannuation dependants but generally cannot be paid death benefit pensions and must receive super death benefits as a lump sum. Individuals who are not superannuation dependants must receive super death benefits indirectly through the LPR (deceased’s estate).

Taxation of death benefit lump sums

Tax dependants include:

the deceased’s spouse or former spouse
the deceased’s child aged less than 18
a person who is financially dependent on the deceased at the time of death
a person who had an interdependency relationship with the deceased at the time of death.

Super death benefit lump sums are tax free to tax dependants, regardless of tax components of the benefit.

However, for those who are not tax dependants, for instance adult children or siblings, the taxable component of the lump sum is assessable. Tax offsets apply to limit the tax on the taxable component to the following rates:

Table 1

Tax component	Maximum tax rate^
Tax free	Not assessable
Taxable - taxed element - untaxed element¹	15% 30%

¹ The untaxed element arises where the death benefit lump sum is paid by an untaxed super fund or if some or all the payment composes life insurance proceeds where the super fund trustee claimed tax deductions for the premiums.
^{^} The Medicare levy may also apply if paid as a lump sum directly from the fund to a non-tax dependant beneficiary.

The tax outcomes for non-tax dependants will depend on whether the super fund trustee makes the payment directly to them or through the deceased estate. It may also impact on any income-tested concessions they are entitled to receive or create tax obligations such as Division 293 tax.

Death benefit lump sum paid via deceased estate

The super fund trustee will pay the death benefit lump sum to the LPR (via the deceased estate) without deducting any tax. The LPR is liable for any tax payable on the taxable component to the extent it benefits non-tax dependants. That portion of the taxable component is included in the deceased estate’s assessable income, which is taxed at individual tax rates. However, tax offsets apply, limiting tax rates on the taxable component to 15% or 30% (see Table 1).

The deceased estate does not pay the Medicare levy nor the Medicare levy surcharge, however it is not eligible for the low income tax offset and the low and middle income tax offset.

The LPR distributes the benefit to intended beneficiaries after paying tax, according to the deceased client’s Will, or where the client dies intestate according to state or territory law. As the benefit has been assessed to the LPR, it is not assessable to the recipient.

Example 1 – Death benefit paid via deceased estate

Garry passes away leaving a super death benefit of $2,000,000 including life insurance proceeds. The super fund trustee pays the death benefit lump sum to the LPR. The proportion of its tax components are:

$1,000,000 tax free (50%)
$500,000 taxable (element untaxed) (25%)
$500,000 taxable (element taxed) (25%)

_________________________________________________

$2,000,000 total super death benefit lump sum

Garry’s Will provides that the benefit be paid to:

$1,000,000 Carrie, his spouse
$500,000 Antonio (adult child aged 32), self-employed with annual income of $180,000 p.a.
$500,000 Melanie (adult child aged 27), single with one child (aged 4), earning $10,000 p.a. She makes non-concessional contributions annually to receive the Government co-contribution. She receives the full rate of Family Tax Benefit (FTB) A and FTB B.

We assume the deceased estate has no other taxable income and no deductions. The LPR pays tax at individual tax rates on $500,000 relating to the proportion of the taxable component (50%) that Antonio and Melanie will receive ($1,000,000 combined). Tax offsets limit the effective tax to a maximum of 30% and 15% respectively). The table shows the tax paid by the LPR and amounts distributed to the beneficiaries.

Table 2

Beneficiary	Antonio and Melanie (non-tax dependants)	Carrie (tax dependant)
Super death benefit lump sum’s tax components:	$500,000 tax free $250,000 taxable - untaxed $250,000 taxable - taxed	$500,000 tax free $250,000 taxable - untaxed $250,000 taxable - taxed
Gross	$1,000,000 ($500,000 each)	$1,000,000
Taxable component assessed to LPR	$250,000 taxable (untaxed) $250,000 taxable (taxed)	Nil
LPR taxed at individual tax rates. Tax offsets limits tax rates to: 30% on taxable (untaxed) ¹ 15% on taxable (taxed) ² Total tax	$ 66,592 $ 37,500 $104,092
Net after tax	$895,908	n/a
Death benefit paid	$447,954 each	$1,000,000

¹ Individual tax rates allow the $18,200 tax free threshold, 19% tax rate from $18,201 to $45,000 ($5,092), tax offset applies to limit tax to 30% (instead of 32.5%, 37% and 45%) on from $45,001 to $250,000 ($61,500).
² Tax offset applies to limit tax to 15%.

The taxable portion of the death benefit is excluded from the beneficiaries’ assessable income and therefore does not impact on any income tested concessions they are entitled to receive (see ‘Impact on income tested concessions’ below).

Death benefits paid to the LPR form part of the deceased estate. Your client should consider the possibility of any claims by eligible persons on their estate which may result in benefits being paid to unintended beneficiaries. Furthermore, by nominating the LPR, there can be delays when administering the estate and beneficiaries may have to wait longer for entitlements.

Death benefit lump sum paid directly to non-tax dependant

A super death benefit paid directly to a beneficiary is not an asset of the deceased estate and generally is not subject to claims on the deceased estate (however, notional estate provisions exist in NSW). Where the deceased expects to have claims against their estate, (eg family or creditors), paying the death benefit directly to intended beneficiaries can help protect the benefit.

Where the beneficiary is a non-tax dependant, the super trustee deducts withholding tax from the tax components of the lump sum at these rates:

Table 3

Tax component	Maximum tax rate
Tax free	Not assessable
Taxable - taxed element - untaxed element	17% 32%

Tax deducted by the super fund trustee is not a final tax. The taxable component of the lump sum is included in the non-tax dependant’s assessable income which may be reduced by allowable deductions. Taxable income is taxed at individual tax rates, however tax offsets apply to ensure the tax paid on the taxable component does not exceed the rates in Table 1. The Medicare levy and the Medicare levy surcharge can apply, depending on income and private health insurance arrangements. A tax credit representing tax withheld by the super fund trustee will reduce the final tax.

Impact on income-tested concessions

An increase in the beneficiaries’ taxable income can result in the loss of concessions based on taxable or assessable income, for example:

Commonwealth Seniors Health Card
Family Tax Benefit (FTB) entitlements
Child Care Subsidy
Carer Allowance
Government co-contribution
Spouse contribution tax offset
Low income super tax offset
Invalid and carer tax offsets, seniors and pensioners tax offset, or private health insurance tax offset

Beneficiaries may be required to pay more tax or to repay certain debt earlier. For example:

Medicare levy
Medicare levy surcharge
Study and training support loan repayments (e.g. HELP, VET Student Loans, Student Financial Supplement Schemes)
Division 293 tax (additional 15% on certain concessional contributions)
Child support obligations

You should consider the loss of concessions and increased tax obligations in addition to the amount of tax paid on the death benefit.

Example 2 – Death benefit paid directly to beneficiaries

In this example, we use the same benefit amounts as used in example 1, though compare the outcomes for the beneficiaries when the death benefits were paid directly to them, instead of via the deceased estate.

Carrie

The super fund trustee pays Carrie a lump sum of $1,000,000 composed of the following tax components:

$500,000 tax free (50%)
$250,000 taxable (element untaxed) (25%)
$250,000 taxable (element taxed) (25%)

_________________________________________________

$1,000,000 total death benefit lump sum

The amount paid to Carrie is tax free regardless of its tax components because Carrie is a tax dependant. Whether the benefit is paid directly or indirectly does not matter, as in both scenarios the benefit is tax free and there is no impact on any concessions based on her taxable income.

Antonio and Melanie

The super fund trustee pays Antonio and Melanie $438,750 each after deducting withholding tax from the taxable components as shown below:

Tax component	Amount
Tax free Taxable (element untaxed) Less 32% withholding tax Taxable (element taxed) Less 17% withholding tax	$125,000 ($40,000) $125,000 $21,250	$250,000 $ 85,000 $103,750
Received net of $61,250 withholding tax		$438,750

The taxable component is assessable income for Antonio and Melanie. Using 2021-22 tax rates here are the tax outcomes for Antonio and Melanie where Antonio has other income of $180,000 and Melanie has other income of $10,000.

Non-tax dependant	Antonio		Melanie
	Taxable Income	Tax	Taxable Income	Tax
Annual income Taxable (untaxed element) Taxable (taxed element)	$180,000³$125,000 $125,000	$51,667 $37,500¹ $18,750²	$10,000³$125,000³ $125,000	- $29,092¹ $18,750²
Tax Free	$250,000	Nil	$250,000	Nil
Total	$430,000	$107,917	$260,000	$47,842
Credit for tax withheld		(61,250)		($61,250)
Tax & Medicare levy⁴		$55,267		$5,200
Tax refund		n/a		($8,208)
Death benefit net of tax & Medicare levy		$438,750		$446,978

¹ A tax offset applies to reduce tax at marginal tax rate from 45% down to 30%.
² A tax offset applies to reduce tax at marginal rate from 45% down to 15%.
³ The first $18,200 is within the tax free threshold.
⁴ Assume beneficiary has eligible private health insurance.

Analysis - Antonio

Antonio is a high income earner. His net benefit after tax is $9,204 more ($447,954 less $438,750) if the benefit is paid through the deceased estate as the Medicare levy does not apply and he partially benefits from the deceased estate’s $18,200 tax free threshold.

Where the benefit is paid directly to him, his income exceeds the $250,000 Division 293 threshold therefore his concessional contributions for the income year are subject to Division 293 tax (in addition to the 15% contributions tax).

Analysis - Melanie

Melanie receives $976 less ($447,954 less $446,978) if the death benefit is paid directly to her. She becomes ineligible for FTB A ($5,774.30) and FTB B ($4,620.90), totalling $10,395.20 including the supplements at 20 Sept 2021) because her income exceeds FTB income thresholds. Non-concessional contributions will not qualify her for the Government co-contribution ($500) and she will not be eligible for any low income super tax offset.

If her death benefit is paid through the LPR she can continue to benefit from these entitlements as the death benefit is not assessed to her.

Tech tip: The benefits of paying super death benefits intended for non-tax dependants through the LPR are: The taxable component is assessed to the deceased estate rather than to the beneficiary. This may help the beneficiary retain certain income tested benefits and concessions. The deceased estate does not pay the Medicare levy and the Medicare levy surcharge. The LPR may, subject to the provisions in the Will, have more flexibility in paying benefits more tax effectively to beneficiaries. However, a death benefit paid via the deceased estate may be subject to claims by eligible persons. Payments from the estate can also be delayed. The benefits of paying death benefits directly to beneficiaries are: Generally the death benefit will not be included in claims against the deceased’s estate (except for ‘notional estate’ provisions in NSW). Death benefits may be paid by the super trustee earlier and with fewer complications with a valid binding death benefit nomination. The benefit is more likely to pass to the intended beneficiaries. Family conflicts may be avoided. However, any taxable component increasing the beneficiaries’ taxable income may impact on any income tested concessions they enjoy. Re-contribution strategies to reduce the taxable component should be considered where possible.

Conclusion

Binding death benefit nominations in favour of non-tax dependants may not always be a good strategy where there the client does not anticipate a claim on their estate. This approach does not provide flexibility in distributing death benefits tax effectively and can impact on the recipient’s income tested benefits.

Super death benefits paid indirectly to non-tax dependants via the deceased estate may be more beneficial. Apart from the Medicare levy not applying, it may allow the beneficiary to retain benefits that are subject to income testing.

On the other hand, where your client anticipates a potential claim on their estate, paying death benefits directly to intended beneficiaries may provide better protection.

More information

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

Disclaimer
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.