Many people we deal with are blissfully unaware that their super beneficiaries may end up paying a large amount of tax on their account balance when they pass away. This applies to all people but particularly those who have relied upon their employer mandated contributions or made personal deductible contributions, such as small business owners.
Super is either Taxable or Tax free
Most people only see their super balance as one figure but underneath, it is actually made up of two important components; taxable and tax free. Every time a contribution is made it gets allocated to one of these components and has an effect on how super withdrawals are taxed when money is released. Most commonly this is in retirement before age 60 but it also includes early release for situations like total and permanent disability and death benefits. For the majority of someone’s working life they can be forgiven for not taking any notice of this – and for good reason – there are more important things to focus on, however, as people near retirement it is something to be aware of.
What is Tax Free Super?
For the purpose of this article I am going to focus on what happens to this money when you pass away. Fortunately the names given to the components give you a good indication as to how they might be applied from a tax point of view. As you can imagine, the ‘tax free’ component, as it suggests, is released tax-free. Money is allocated to the ‘tax free’ component when a tax deduction has not been claimed at time of contribution.
What is Taxable Super?
Unfortunately, the more common form of super contributions are from employers or small businesses where a tax deduction was claimed either by you or the business owner making the contribution. This includes all Super Guarantee 9.5%, salary sacrifice and personal deductible contributions. These contributions have 15% tax taken out on the way in and get recorded under the ‘taxable’ component. This is the money you need to be concerned about and who it will be left to as a nominated beneficiary when you die. If the person (or people) you have nominated are classed as dependents, your super balance will be paid out to them tax free. This can include people such as; your spouse, ex-spouse, children under 18 years or anyone else who was financially dependent or in an interdependency relationship with you at the time of your death. You will notice this does not include nominating your estate or other people, such as adult children. If a non-dependent beneficiary has been nominated the taxable component will be taxed at 15% plus Medicare (currently 2%) = 17%.
How taxable super can impact your ‘Estate Tax’
Let us look at an example. Peter has recently re-married and has two adult children in their 30s that he would like to leave an inheritance to. He has a super account balance with $300,000 which has been made up of mostly employer contributions over his working life. His taxable component is $280,000. Peter currently has his two adult children listed as the nominated beneficiaries on his super fund. If Peter were to pass away, his children would pay 17% tax on his $280,000 taxable component, which works out to be $47,600! This is significant and would most likely be a rude shock to his children.
On the other hand, had he left his super money to his new wife, she would pay zero tax on this money. Both of these outcomes are problematic as neither meet Peter’s wishes. Rest assured, with careful strategic planning there are alternative ways to reduce this ‘estate tax’.