Did you know? By 1895 each Australian State had introduced its own inheritance (estate) tax. This tax was also often referred to as “death duties”.
Federal estate tax was introduced in 1914 but was abolished 65 years later, in 1979.
The States have also abolished their inheritance taxes, starting with Queensland in 1978. By 1982, all States had abolished their state-based death duties.
Death Duties today
While it is true Australia no longer has an inheritance tax or death duties in the strict sense of the word, there are some taxes that may become payable on a person’s death.
Capital Gains Tax
While death itself will generally not trigger a liability to pay capital gains tax, when certain assets are sold by a person’s estate or by beneficiaries that inherit those assets, the disposal may result in capital gains tax becoming payable.
The rules governing capital gains tax are complex and will depend on the nature of the assets (e.g. shares, investment properties, former main residence). In some circumstances the sale of an asset may be exempt from capital gains tax (such as the sale of a former main residence that is sold within two years of death).
When dealing with a deceased estate, guidance from a suitably qualified accountant or tax agent is recommended to ensure liability for tax is managed appropriately.
Another significant area of inheritance tax “by stealth” is a deceased person’s superannuation benefits.
Superannuation held by a person at the time of their death may include benefits in the accumulation phase, the pension phase, or a combination of both.
Superannuation benefits may be minimal – perhaps a few thousand dollars, or they may be significant – potentially hundreds of thousands or even millions of dollars.
When a member of a superannuation fund passes away, their superannuation savings must be cashed “as soon as practicable” following death. While “as soon as practicable” is not specifically defined in legislation, it is generally expected superannuation death benefit should be paid within six months of a person’s death. However, this may not always be possible, particularly where a dispute occurs, there is difficulty in locating potential beneficiaries, or where superannuation assets cannot be readily sold.
Superannuation death benefits can be cashed in two ways:
- Payment of a pension to certain eligible beneficiaries – generally to a surviving spouse; and/or
- Payment of a lump sum to nominated beneficiaries or to the estate of the deceased.
Superannuation law imposes restrictions on the classes of beneficiaries that can receive a death benefit directly from a superannuation fund, either in the form of a pension paid on the death of a member, or as a lump sum. Often superannuation funds will pay a member’s death benefit to their legal personal representative to be dealt with as part of their estate.
Death benefits are also not just governed by superannuation law. They are also impacted by taxation law.
A superannuation death benefit paid as a lump sum is tax free when paid to a “dependant” (as defined in tax law). Where the death benefit is paid to the estate of the deceased, a “look through” is applied to determine who the eventual beneficiary of the superannuation death benefit will be. If the ultimate beneficiary is a “tax dependant”, the benefit is tax free.
A tax dependant includes:
- The spouse, or former spouse of the deceased,
- The deceased’s children under 18 years of age,
- Anyone with whom the deceased had an interdependency relationship just before they died, or
- Any other person who was financially dependent on the deceased at the time of their death.
In general terms, parents, brothers and sisters, adult children, and grandchildren of a deceased person are unlikely to be a tax dependant of the deceased. Financial dependency can be difficult to determine.
When a superannuation benefit is paid to a person other than a tax dependant, we need to determine the components of a deceased member’s death benefit. This information can be obtained from the deceased’s superannuation fund.
Tax components may include one or more of the following:
- Tax-free component
- Taxable component – taxed element
- Taxable component – untaxed element
The tax-free component generally comprises of contributions made to superannuation for which a tax deduction has not been claimed. This includes non-concessional contributions and downsizer contributions.
The taxable component – taxed element will comprise of tax-deductible contributions (including those made by employers and personal tax-deductible contributions) and investment earnings on contributions.
A taxable contribution – untaxed element will include certain contributions made to an untaxed superannuation fund – generally older style funds for public servants. Life insurance proceeds paid to a deceased member’s account following the member’s death may also give rise to an untaxed element.
When a death benefit is paid, the components are taxed in the following manner:
- Tax-free component – is exempt from tax
- Taxable component – taxed element – taxed at 15%
- Taxable component – untaxed element – taxed at 30%
If a superannuation fund pays a death benefit directly to a beneficiary, rather than to the estate, Medicare Levy (2%) is added to the tax rates mentioned above.
One of the questions often asked by seniors, particularly when it is likely their super will pass to non-tax dependants such as adult children, is whether super should be withdrawn as a lump sum while they are still living?
Remember, the tax-free component and taxable component – taxed element withdrawn as a lump sum by a member aged 60 or older, who is still living, is exempt from tax.
The answer to this question is – it depends!
For example, if a member’s superannuation balance comprised entirely or has a significant portion of tax-free component, the tax payable on death will be minimal, if any.
However, if the benefit includes a significant portion of taxable component, then the progressive drawing down of super as a person ages, may be worth considering.
Of course, if superannuation is withdrawn and invested outside of the superannuation system, income earned on the investments, and capital gains, will be taxable.
At the end of the day, managing superannuation in our maturing years will depend on several factors including:
- Who is the likely beneficiary – a tax dependant or a non-tax dependant?
- What are the components of the superannuation benefit – tax-free, taxable, or a combination?
- What tax is likely to be payable if superannuation is withdrawn and is invested outside the superannuation system?
- What is the member’s current health status and longevity outlook?
Unfortunately, there is no simple answer to avoiding tax payable on superannuation death benefits however there are strategies that can be drawn upon to minimise tax.
As every person’s situation will be different, seeking appropriate advice from a licensed financial adviser is recommended.
Author: Peter Kelly | 14 September 2022
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