Understanding Estate Planning and Super Death Benefits
Estate planning is an essential part of your overall financial plan that ensures the protection of your family and when you’re not able to make these decisions yourself. The aim is to ensure that your assets are distributed as intended upon your death and that your finances are managed appropriately.
Wills, Powers of Attorney, and Testamentary Trust are three key aspects of estate planning.
Wills
A will is a legal document that outlines your wishes for how to distribute your assets after your death. For example, you might have a house, a car, and a significant amount of money in savings. In your will, you could specify that the house goes to your spouse, the car goes to your eldest child, and the money is divided equally among all your children. It’s important to note that a will only covers assets that end up in your estate, which does not include jointly owned assets, assets held in a private company or family trust, insurance policies where someone else is the direct beneficiary, and superannuation unless paid to your estate by the trustee.
Powers of Attorney
This is a legal document that allows someone else to act on your behalf, typically in financial matters. For example, if you were to become mentally incapacitated, a Power of Attorney would allow a person you trust to handle your affairs. This could include paying bills, managing investments, or selling property. There are different types of Powers of Attorney, including a General Power of Attorney, which may be for a specific action or broad powers, and an Enduring Power of Attorney, which allows a person to act on your behalf when you are no longer able to do so yourself due to diminished mental capacity.
Testamentary Trust
This is a trust set up in your will that comes into effect after your death. For example, you might want to leave a significant amount of money to your children, but you’re worried they might spend it. By setting up a Testamentary Trust, you could specify that they only receive a certain amount each year, or that the money can only be used for specific purposes like education or buying a home. The trust is managed by a trustee, who is responsible for the daily running of the trust and decides who will receive distributions. There’s also an appointer, who has the authority to remove the trustee and appoint a replacement.
Remember, it’s important to seek legal advice when setting up these documents to ensure they are properly drafted and reflect your wishes.
Understanding super death benefits
Super Death Benefits refer to the remaining superannuation that a person has when they die. In most cases, the super fund pays this remaining amount to the nominated beneficiary of the deceased. This payment is known as a ‘super death benefit’.
The beneficiary can be nominated by the deceased in a binding or non-binding nomination, provided that the super fund rules allow it. In a binding death benefit nomination, the deceased can nominate one or more dependents and/or their legal personal representative to receive their super. If the deceased did not make a nomination, or if they made a non-binding nomination, the trustee of the fund may use their discretion to decide which dependent or dependents to pay the death benefit to, or make a payment to the deceased’s legal personal representative for distribution according to the instructions in the deceased’s will.
The death benefit can be paid to a dependent of the deceased as either a lump sum or an income stream. However, if it is paid to someone who is not a dependent, it must be paid as a lump sum.
Under superannuation law, a dependent is defined as a spouse or de facto spouse, a child of the deceased (of any age), or a person in an interdependency relationship with the deceased. An interdependency relationship exists when two people have a close personal relationship, live together, and one or both provide the other with financial support. If a person wishes to leave their super to someone who is not a dependent under superannuation law, they can do so by making a binding death benefit nomination to have the payment made to their legal personal representative.
For tax purposes, a dependent is defined similarly, but there are additional conditions related to financial dependency and disability. For example, children over 18 years old must be financially dependent on the deceased to be considered a dependent. There are also limits on who can receive a death benefit income stream.
If you believe you’re the beneficiary of a deceased person’s super or are the legal representative of a person’s estate, you should contact their super fund to let them know that the person has died and ask them to release the person’s super.
How super fund lump sums are distributed
A lump sum superannuation death benefit can be distributed in two ways to a SIS dependent who is a non-tax dependent, such as an adult child:
- The lump sum death benefit can be paid directly from the deceased member’s super fund to the beneficiary
- The lump sum death benefit can be paid to the deceased’s estate and then distributed to the beneficiary.
In both cases, the tax-free component can be received tax-free. The taxable taxed element is subject to a maximum 15% tax and the taxable untaxed element is subject to a maximum 30% tax.
The tax practice to calculate the lump sum tax offset consists of three steps:
Step 1: Include the taxpayer’s ordinary taxable income subject to marginal tax rate.
Step 2: Add amounts taxed at a higher maximum tax rate, such as the taxable untaxed element of the lump sum death benefit that is subject to 30% maximum tax rate.
Step 3: Add amounts taxed at a lower maximum tax rate, such as the taxed element of the lump sum death benefit that is subject to 15% maximum tax rate.
The beneficiary, whether a tax resident or a foreign resident, is liable to pay tax on the lump sum death benefits. The tax rates apply differently based on the tax residency status of the beneficiary. If the beneficiary is a resident, the trustee of the super fund must withhold tax on the taxable component of the lump sum. The beneficiary then needs to declare the taxable taxed and untaxed elements in their tax return as assessable income.
If the beneficiary is a foreign resident, the same maximum income tax rates apply. However, the tax-free component is free.
In both cases, the tax outcome can be different for the beneficiary depending on whether the lump sum death benefit is paid directly or through the estate.
Tax considerations
Superannuation death benefits are subject to different taxation rules depending on the recipient’s relationship to the deceased.
If the death benefit is paid to a dependent of the deceased, it can be paid as either a lump sum or income stream. In this case, the tax treatment of the taxable component is non-assessable non-exempt income, which means no tax is levied on it. This applies to both the taxed and untaxed elements of the superannuation death benefit.
If the death benefit is paid to someone who is not a dependent, it must be paid as a lump sum. The taxable component of the death benefit is treated as assessable income. If the benefit is paid directly from the super fund, the maximum tax is 17% (including Medicare levy) for the taxed element and 32% for the untaxed element. If the benefit is paid indirectly via the deceased’s estate, the maximum tax is 15% for the taxed element and 30% for the untaxed element. Note that the Medicare levy does not apply when superannuation death benefits are paid via the estate.
For children over 18 years old, they must be financially dependent on the deceased to be considered a dependent and receive a death benefit income stream. Children can only receive an income stream if they are under 18, or under 25 years old and are financially dependent on the deceased or have a permanent disability. Adult children with a permanent disability can continue to receive an income stream after they turn 25 years old. In all other situations, the income stream must change to a lump sum on or before the date they turn 25 years old.
It’s also important to note that there are special rules for death benefit income streams in relation to the recipient’s transfer balance cap. This is a lifetime limit on the maximum amount that can be transferred into one or more tax-free retirement accounts. If a recipient starts to receive a death benefit income stream, a credit arises in their transfer balance account. The amount and timing of the credit depend on when they started receiving the death benefit income stream, and whether it’s reversionary or non-reversionary.
Estate planning and understanding super death benefits are crucial aspects of financial planning. They ensure that your assets are appropriately distributed upon your death and can result in significant tax savings for your beneficiaries. It’s always advisable to seek legal advice when setting up your estate plan and understanding the tax implications of super death benefits.
This information is general advice. We have not considered your objectives, personal or financial circumstances. You should consider the appropriateness of the advice for your circumstances before making any decision. You should obtain and consider the relevant Product Disclosure Statement and seek the assistance of an authorised financial adviser before making any decision regarding any products or strategies mentioned in this communication.
