When it comes to superannuation death benefits, understanding the taxation implications is crucial. Whether a lump sum death benefit is taxable depends on various factors, including the components of the benefit and whether it is paid to a tax-dependent individual or not. In this comprehensive guide, we’ll break down the taxation rules for both tax-dependent and non-tax-dependent beneficiaries.
Taxation for Tax-Dependent Beneficiaries
Lump Sum Payment to Tax Dependents: If a lump sum death benefit is paid to a tax-dependent, such as a spouse or minor child, it is typically tax-free. In this case:
- The super fund is not required to withhold any tax.
- The beneficiary receives the death benefit tax-free, and no payment summary is provided by the superannuation fund.
Payment to an Estate with Tax-Dependent Beneficiary: When a death benefit is paid to an estate, and the ultimate beneficiary is a tax-dependent, no tax applies. However:
- The superannuation fund must still prepare a payment summary for the executor.
Payment to an Estate with Non-Tax-Dependent Beneficiaries: If an estate includes non-tax-dependent beneficiaries, tax will be applicable at the estate level. In this scenario, the tax treatment depends on the components of the benefit.
- If all beneficiaries are tax-dependents, the estate remains tax-free.
- If non-tax-dependent beneficiaries are part of the estate, tax will be levied at the estate level.
In both cases, the amounts received by tax-dependent beneficiaries are considered non-assessable non-exempt (NANE) income, which does not impact their tax position or benefits like Family Payments and Child Support.
Taxation for Non-Tax-Dependent Beneficiaries
Lump Sum Payment to Non-Tax Dependents: When a death benefit lump sum is paid to a non-tax-dependent, such as an adult child, taxation rules differ:
- The super fund is required to withhold tax on any taxable component (taxed and untaxed).
- Withholding rates are 15% plus the Medicare levy for taxed elements and 30% plus the Medicare levy for untaxed elements.
- The tax-free component remains tax-free, with no withholding requirements.
- The super fund provides the beneficiary with a payment summary.
- The beneficiary includes taxable elements in their individual tax return and may receive a refund if their tax payable is lower than the withholding amount.
Maximum Tax Rates for Lump Sum Payments to Non-Dependants:
- Taxed element of the benefit: Maximum 15% plus Medicare levy.
- Untaxed element of the benefit: Maximum 30% plus Medicare levy.
- Medicare levy applies when the payment goes directly from the super fund to a non-dependent beneficiary.
For detailed withholding requirements, refer to the tax table for superannuation lump sums on the ATO page.
Taxation for Payments to an Estate:
- Super funds do not withhold tax when payments are made to an estate.
- The super fund prepares a payment summary for the executor, who is responsible for paying tax at the above maximum rates (Medicare levy does not apply).
- Beneficiaries receive the net proceeds and are not required to include this amount on their tax return.
Calculating the Untaxed Element
Insurance-Based Death Benefits: If a lump sum death benefit includes an untaxed element, it may be sourced wholly or partly from insurance proceeds, resulting in tax implications. Here’s how to calculate the untaxed element:
- Untaxed Element = Taxable Component – Taxed Element
- Taxed Element = (Amount of Lump Sum Super Death Benefit × Service Days) / (Service Days + Days to Retirement) – Tax-Free Component
- Days to Retirement: Number of days between the date of death and the deceased’s last retirement date (usually age 65).
- Service Days: Number of days from the day the member joined the fund or the earlier service period start date (if a rollover amount was received) to the date of death.
Death Benefit Income Stream Taxation
- If a death benefit income stream is paid to a dependant, no tax is payable, regardless of the inclusion of an untaxed element.
For Beneficiaries and Deceased Under 60:
- Tax rates vary for taxable components (taxed and untaxed).
- Offset and withholding rules apply.
For Retirement Phase Earnings:
- Death benefit income streams are considered in the retirement phase, resulting in exempt current pension income (ECPI).
- No PAYG obligations or payment summaries are required when either the deceased or surviving spouse is over 60.
Understanding the taxation implications of superannuation death benefits is essential for both tax-dependent and non-tax-dependent beneficiaries. Whether you’re receiving a lump sum or an income stream, knowing the rules and rates can help you make informed decisions about your finances. Please consult a tax professional, such as iCare Super, for personalized advice based on your specific situation.