Who Gets Your Super When You Die?
Our theme this month is estate planning, and so we thought we would start with a quick article about what happens to your super when you die. We know, it sounds grim, but it is not really. After all, the rate of death has remained unchanged for quite a while: we all get one each. And most of us want to die with some money left! An important thing to remember when it comes super is that you are usually not the legal owner of your superannuation benefits. That might sound odd, but the assets are actually owned by the trustee/s of the relevant fund. As your trustees, they owe you a duty to do the right thing by you and to manage the assets for your benefit. But, once you have died, it becomes pretty hard to insist on this, that’s why it is a great idea to establish a ‘binding death benefit nomination’ before you go. Let’s pick that term apart to understand what it means. Death benefits are benefits that remain in the fund and need to be paid out to someone when you die. A nomination is a where you tell the trustees who you want to receive your death benefits. The fact that the death benefit nomination is binding means that the trustees of the fund must pay the death benefits as you have stipulated. It is always worth remembering that superannuation is complex. After all, the rules were dreamed up by politicians and then written up by bureaucrats. One of the complexities is what happens to your death benefits from a tax perspective. Basically, whether these benefits are subject to tax depends on two things: the nature of the benefits and the nature of your relationship with the person who eventually receives them. If the person who receives your benefits is what is known as a ‘death benefit dependant,’ then they will not pay tax. A death benefit dependant is basically:
· Your spouse;
· Your child or children if they are aged under 18; and/or
· Any person who was financially dependent on you when you die. This might include, for example, a 21 year old child still living at home.
If the person who receives the benefits is not a death benefit dependant, then the benefits may be taxed. Once again, this will depend on the nature of the benefits within the fund. All superannuation benefits are divided into one or both of two types: the taxable component and the tax-free component. As these names suggest, tax-free components are not subject to tax when paid out as death benefits, even if the recipient is not a death benefit dependant. Taxable components will be subject to tax if they are paid out to someone who is not a death benefits dependant. Got that?
The point is: if your super will go to someone other than your spouse, your children aged under 18 or someone aged over 18 who is not financially dependent on you, then the taxable component of that super will be taxed. So, from a tax planning perspective, if your benefits are going to be paid out to someone who is not a death benefit dependant, then it is best if your benefits are tax-free to the greatest extent possible.
The thing is, whether the benefits are taxable or tax-free depends on how they got into the fund in the first place. If whoever put them there got a tax deduction for them (think of an employer making a compulsory super contribution), then the benefits will form part of the taxable component. So will investment earnings that are then generated on these benefits. But if there was no tax deduction claimed when the money first entered the fund (known as a ‘non-concessional contribution’), then these benefits will form part of the tax-free component. Tax-free components are never subject to tax when paid out as death benefits, even if the recipient is not a death benefits dependant. The trick, then, is to maximize the proportion of benefits in the fund that derived from non-concessional contributions. This gives rise to a strategy known as a ‘re-contribution strategy.’ In a re-contribution strategy, a fund member who is eligible to do so withdraws benefits from the fund and then re-contributes them back in as a non-concessional contribution. This increases the proportion of benefits held in the tax-free component. This in turn reduces the amount of tax that would be paid by a non-death benefit dependant when eventually the member dies. This really is planning for your beneficiaries. After all, the tax that is being saved was not payable until after you died anyway. But it can be well worth thinking about.
Of course, given the complexity, things must be done right. There are some i’s to dot and t’s to cross. But it is not too difficult when you know what you are doing. So, if you would like to maximize how much of your super actually makes it to your loved ones, talk to us about whether a re-contribution strategy will work in your case.
The tax advice component of this post was created by Dover Financial Advisers, a registered tax (financial) adviser.