The Superannuation Trap That Could Cost Your Kids Thousands

Zoe Kennedy – Financial Adviser

In 1983, Australia abolished what were once known as death duties; estate taxes that could strip up to 27.9% from estates worth more than $1 million. With their abolition Australian’s have long assumed our country is free of inheritance taxes. However, while traditional estate duties are gone, certain taxes can still apply after death and one of the most significant is embedded within the superannuation system.

As superannuation becomes the primary wealth-building vehicle for many Australians, understanding how it is treated after death has never been more important.

In most cases, superannuation death benefits are paid tax-free to dependants. For this purpose, a dependant generally includes a spouse or children under 18. Since super is most often passed to a surviving spouse, there is usually no tax liability. Similarly, any super withdrawn by the member themselves after the age of 60 is also generally tax-free.

The tax issue arises when super is paid to adult children or other non-dependant beneficiaries. In these cases, recipients are required to pay 15% tax on the taxed component of the benefit, plus a further 2% Medicare levy. For example, a $1 million taxed component could result in $150,000 in tax, plus Medicare levy, unless the benefit is paid to the deceased’s estate, which is not subject to the levy.

The size of this liability depends on the composition of the super balance. The taxed component generally consists of taxable contributions (such as employer super guarantee and salary sacrifice amounts) plus fund earnings over time. The tax-free component typically reflects non-concessional contributions made from after-tax income.

Where no qualifying dependants are nominated, and a death benefit is destined for non-dependants, the taxed component becomes key in determining the final tax payable. Some people choose to reduce their super balance to limit future death benefits tax, by withdrawing eligible amounts and investing them elsewhere. However, access to super is generally limited to those who have met a condition of release, such as reaching preservation age and retiring, or turning 65.

Any decision to move funds out of a concessionally taxed or tax-free environment of super comes with broader considerations from the potential impact on asset protection and estate planning, to the suitability of alternative investment structures and income tax.

The bottom line. Super remains one of the most tax-effective ways to build and manage retirement wealth. Yet, without foresight, it can also create an unexpected tax bill for the next generation. Awareness of how death benefits are taxed, understanding your super’s components, and carefully reviewing beneficiary arrangements can help ensure that more of your legacy goes to the people you intend.

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