Calculating super lump-sum death benefits

One outcome of the growing popularity of superannuation as a wealth creation vehicle is that more adults will receive death benefits from their parents’ super account/s. This article will look at the treatment of life insurance proceeds included in a super lump sum death benefit payment to non-tax dependants.

Where the proceeds of a term life insurance policy are allocated to a deceased member’s superannuation interest, they will form part of the taxable component of that interest. If a deceased member’s interest is then paid as a lump sum to a tax dependant, the entire payment will be tax free (i.e. non-assessable, non-exempt income). Therefore, the super fund trustee generally will not be required to calculate the tax components or withhold any tax from the payment.

Tax dependants (in relation to the member) are as follows:

  • Spouse (including de facto and same sex)
  • Former spouse1
  • Child under age 18
  • Financial dependant (including financially dependent adult child)
  • Interdependent relation
  • Individual who receives super lump sum death benefit where the deceased died in the line of duty

A super death benefit may be paid directly to a superannuation dependant or to the member’s legal personal representative (LPR). Where a death benefit is paid to a LPR as executor of an estate, no tax is withheld by the trustee of the super fund. To the extent that non-tax dependent beneficiaries will (or could be expected to) benefit from the death benefit, it is subject to the same taxation in the estate as a non-tax dependant would pay had they received the benefit directly. However, Medicare levy does not apply.

Where a fund pays a super death benefit as a lump sum from accumulation phase to a non-tax dependant, the trustee will need to withhold tax from the taxable component as per the following table:

Member-owned strategy – Permitted

Tax component Tax rate
Tax free component Nil (non-assessable non-exempt income
Taxable component (taxed element) 15%
Taxable component (untaxed element) 30%

*Medicare levy is also payable on the amount except where death benefit is paid to the member’s estate.

Where a member’s lump sum death benefit does not include any insurance proceeds, the whole of the taxable component will generally consist of a taxed element. However, where the lump sum death benefit includes  insurance proceeds (even $1) and the trustee has claimed, or will claim a deduction for the cost of the insurance premiums (or claim a deduction for a future liability to pay benefits), the taxable component will also include an untaxed element.

The process to calculate the untaxed element is specified in section 307-290 of ITAA 1997 and is as follows:

Step 1 Calculate the taxable component (taxed element) Page 2 of 3

1 An ex-spouse is not recognised as a superannuation dependant. It is unlikely for a super death benefit to be paid to an ex-spouse.

Where:

  • Days to retirement = the number of days between the date of death and the deceased’s
    last retirement date (generally age 65).
  • Service days = is the number of days from the day the member joined the fund (or if a rollover amount was received by the fund with an earlier service period start date, that earlier start date) to the date of death. For an employer sponsored fund, service days may commence when the members employment commenced, if that was prior to the commencement of their fund membership.

Note: If the calculated result is negative (i.e. where the tax-free component is large in relation to the total benefit), the taxed element in the fund is nil and the residual amount – after taking the tax free component into account – is deemed to be a wholly untaxed element in the fund.

Step 2 Calculate the taxable component (untaxed element)

Untaxed element = taxable component – taxed element

Case study

Alan dies at the age of 55. He set up a self-managed super fund (SMSF) two years ago and made both concessional and non-concessional contributions. At the date of his death, he had $1 million of term life cover through his fund as well as an existing SMSF balance of $400,000 (50% of which was tax free). Alan named his adult, non-dependent daughter Katie as the sole beneficiary of his superannuation benefit (directly, not via his will).

Alan also had a super fund account with a small industry fund worth $300 which he set up 20 years ago and considered consolidating into his SMSF, but never got around to it. Let’s look at how this potential rollover would have impacted on the untaxed element of his lump sum super death benefit, together with a benefit payment in  favour of Katie via Alan’s estate rather than directly.

No rollover Rollover
Service period (assuming 365 days per year) Service days: 730
Days to retirement: 3,650
Service days: 8,030
Days to retirement: 3,650
Tax-free component $200,000 $200,000
Taxable component (taxed element) $33,333 $762,500
Taxable component (untaxed element) $1,166,667 $437,500
Total lump sum death benefit $1,400,000 $1,400,000
Tax $379,000 (includes Medicare levy) $245,625 (no Medicare levy)
Net death benefit $1,021,000 $1,154,375

*$300 rollover balance ignored due to small value

The longer the existing service period of a client’s superannuation interest, the less untaxed element their lump sum death benefit will contain. As you can see from the above table, Alan could have saved Katie $133,375 by rolling over his industry fund with a longer existing service period into his SMSF and nominating his estate as the recipient of his death benefit and adjusting his will accordingly.

At the same time, it is important to note that where a client holds life and TPD cover through super, the above strategy will reduce the increased tax-free component calculation that would apply to a lump sum disability super benefit paid via the same superannuation interest. Alternatively, a client can look at taking term life and TPD cover outside (or converting an existing super policy to non-super, if available), which would avoid any tax liability to a nominated beneficiary or to the client themselves.

Summary

A superannuation death benefit which includes life insurance may potentially give rise to an increase in tax liability when paid to a non-tax dependant. However, clients may be able to minimise this liability with relatively simple strategies, usually with the help of their financial advisers.

This information is current as at September 2018. This article is intended to provide general information only and has been prepared without taking into account any particular person’s objectives, financial situation or needs (‘circumstances’). Before acting on such information, you should consider its appropriateness, taking into account your circumstances and obtain your own independent financial, legal or tax advice. You should read the relevant Product Disclosure Statement (PDS) before making any decision about a product. While all care has been taken to ensure the information is accurate and reliable, to the maximum extent the law permits, ClearView and its related bodies corporate, or each of their directors, officers, employees, contractors or agents, will not assume liability to any person for any error or omission in this material however caused, nor be responsible for any loss or damage suffered, sustained or incurred by any person who either does, or omits to do, anything in reliance on the information contained herein.