Who pays tax and how much when a superannuation fund pays out death benefits to a deceased estate or to a testamentary trust is not intuitive. The two technical concepts of “dependant” and “taxable component” in particular are a source of confusion.
There are two relevant kinds of dependant. The SIS Act kind of dependant (a spouse of the person, any child of the person and any person with whom the person has an interdependency relationship – section 10 of the Superannuation Industry (Supervision) Act 1993) notably differs from a death benefits dependant under section 302-195 of the Income Tax Assessment 1997 , a subset of (SIS Act) dependant, as a death benefits dependant excludes adult children who are not disabled or in an interdependency relationship. Such an independent adult child can be a (SIS Act) dependant in receipt of a death benefit from a superannuation fund but is not a (section 302-195 of the ITAA 1997) death benefits dependant.
For tax purposes a death benefit is split into a taxable component and a tax fee component. The tax free component is tax free to any dependant but the taxable component is a misnomer when paid to a death benefits dependant (DBD): it’s tax free too! So of the four permutations (tax free to DBD, tax free to Non-DBD, taxable to DBD, taxable to Non-DBD) it is when a death benefits dependant receives a death benefit comprising taxable component that the benefit becomes taxable.
Superannuation benefits can be paid prior to death if a member has satisfied a condition of release such as reaching the age of 65 years. This can be a way of reducing the taxable component of a death benefit that might be taxable to a dependant when paid after the member’s death. Member benefits, viz. benefits withdrawn by a member during his or her lifetime, are generally not taxable to the member where the member has reached aged 60. It is permissible to re-contribute withdrawn benefits as non-concessional contributions back into superannuation, which become tax free component, when later paid out by the superannuation fund as death benefits.
Non-concessional limits and caps on re-contribution
However the member must be within non-concessional contribution limits to re-contribute back into superannuation in this way. At over age 65 that involves meeting the work test and being within the non-concessional caps. That is being under:
- annual non-concessional contributions of $100,000 p.a. (no bring forward allowed for over age 65s); and
- a total superannuation balance of $1.6m.
A look at how a taxable death benefit is taxed
A payment of death benefit that flows to a beneficiary of a deceased estate is something of a three stage event. The tax system looks through to the ultimate dependant in receipt of the death benefit (the third stage) even though the trustee of the superannuation fund may simply be paying death benefits to the legal personal representative of the deceased member who is an allowable (SIS Act) dependant (the first stage).
Non-death benefits dependants only get lump sum death benefits
Only lump sum death benefits can be paid to a dependant who is not a death benefits dependant, such as an independent adult child, so ordinarily we are looking at tax at 15% on a “taxed element” (the usual source [element] of benefits from a SMSF) but other rates can apply: see this table of rates at the ATO website https://www.ato.gov.au/rates/key-superannuation-rates-and-thresholds/?page=12
A curiosity is that taxable lump sum death benefits received by the trustee of a deceased estate are not subject to the medicare levy. Taxable lump sum death benefits viz. taxable component received directly by a non-death benefits dependant from the trustee of a superannuation fund, that is, not indirectly from the fund via a legal personal representative deceased estate dependant, is subject to medicare levy and PAYG withholding.
No PAYG withholding on lump sum death benefit paid by the trustee of the superannuation fund
The ATO also confirms that a lump sum death benefit is not subject to PAYG withholding where it is paid to:
- a death benefit dependant (tax free); or
- the trustee of a deceased estate – this amount is taxed within the deceased estate broadly in the same way it would be taxed if it was paid directly to the beneficiary.
The trustee of the superannuation fund is obliged to provide a PAYG payment summary – superannuation lump sum form (NAT 70947) to the trustee of the deceased estate within fourteen days of the payment though.
Obligations of the trustee of the deceased estate
According to the 2018 trust tax return instructions at the ATO website https://www.ato.gov.au/forms/trust-tax-return-instructions-2018/?page=43
A superannuation death benefit paid to a trustee is taxed in the hands of the trustee in the same way that it would be taxed if paid directly to a beneficiary, that is, the portions of the payment are subject to tax to the extent the beneficiary is a dependant or a non-dependant of the deceased. There is no tax payable to the extent that the payment is made to dependants or eligible non-dependants of the deceased.
At stage two, the trustee returns the taxable portions applicable to the non death benefits dependants in the trust return so that the ATO can assess the tax payable by the trustee as if the estate beneficiary/non-death benefits dependant was being directly taxed (with the taxed element generally capped to 15%).
This tax is a final tax paid at the trustee of the deceased estate level so no tax at stage three! A trustee of deceased estate should not include taxable elements of a superannuation death benefit lump sum, otherwise returned and directly and finally taxed, in income in its tax return. Then these amounts will not be further taxed at stage three as income say of a resident adult beneficiary.