Death benefits paid to your LPR, also the executor of your estate, are taxed in the same way they would have been had they been paid directly from the fund to beneficiaries of the estate.
Accordingly, where a beneficiary was a “tax dependant” at time of death receives some or all the death benefits, that benefit is tax-free in the hands of the executor.
Tax dependants include your spouse, minor children, someone with whom you were in an interdependency relationship, or someone who was financially dependent on you (which may include a child between 18 and 25 who was dependent on you).
Similarly, where a beneficiary who was a “non-tax dependant” receives death benefits, they are taxed in the estate as if paid directly to the non-tax dependant. Tax on any taxable component is 15 per cent (taxed element) or 30 per cent (untaxed element, such as insurance). As the estate is not subject to Medicare levy, these beneficiaries save two per cent.
When to use a trust
Working out who benefits from an estate is straightforward where death benefits are bequeathed to specific beneficiaries in the will.
It’s more difficult where beneficiaries are not specifically nominated, say where death benefits are paid into a testamentary trust for the benefit of a range of beneficiaries, and it may not be possible to determine the extent non-tax dependants will benefit. Given this uncertainty, many trustees take a conservative approach and treat the entire payment as being paid to a non-tax dependent, with tax on any taxable component levied at up to 30 per cent.
One way to ensure super death benefits paid to an estate remain tax-free is to establish a superannuation proceeds trust (SPT). This is a trust that is funded by superannuation death benefits.
Generally it’s established via your will to manage death benefits for the ultimate benefit of various beneficiaries, instead of those beneficiaries inheriting the benefits directly from the super fund, say for reasons of asset protection.
An SPT established by a will starts when its trustee receives the super death benefits from the executor of the estate.
Beneficiaries of SPTs should only be individuals who were tax dependants of the deceased at the date of death.
There’s no tax on payment of death benefits to the SPT and minor beneficiaries are taxed at ordinary adult rates, rather than at penalty child rates.
Take Doug. When he died, he was survived by his wife Joan and their two children, Janet, 20, and Gary, 16. Janet lives with friends and doesn’t rely on her parents for financial support.
Doug’s death benefit nomination instructed the fund trustee to pay his death benefits of $800,000 to his LPR (being the executor of his estate).
Doug’s will provided for his entire estate, including the death benefits, to be paid into a discretionary testamentary trust, the beneficiaries of which are Joan, Janet, Gary, his brother Raymond and a charity.
While Joan and Gary were Doug’s tax dependants when he died, Janet, Raymond and the charity are not. So the entire death benefit paid to the testamentary trust may be treated as if it had been paid to non-tax dependants. If the entire death benefit comprised a taxable component, there will be tax of at least $120,000 to pay.
Had Doug established an SPT for the benefit of Joan and Gary, and made alternative provision for Janet, Raymond and the charity by allowing them to inherit other assets, this tax could have been avoided.
Also, the SPT enables any earnings, including capital gains, distributed to Gary to be taxed at ordinary adult rates.
Doug could have vested the trustee with wide-ranging powers and the identity of the trustee is not limited, making the SPT extremely flexible.
In addition, trust assets are protected from creditors in the event of bankruptcy of any beneficiary.
An SPT can be a useful vehicle to grow wealth over time for Joan and Gary. Had a superannuation death benefit pension been paid to Gary, it would have needed to cease by his 25th birthday, unless he’s disabled.
To ensure your super is paid in accordance with your wishes to your intended beneficiaries in a tax-effective manner, a range of tax, superannuation, asset protection and estate planning issues need to be considered. The features of SPTs may make them a worthwhile structure to consider.
General advice only. Colin Lewis is head of strategic advice at Fitzpatricks Private Wealth.