If your beneficiaries are adult children and there is no spouse, there are five big tax savings. When you die, there are rules about how, and to whom, your superannuation benefit can be paid.Join our newsletter
In a typical nuclear family, a super benefit can be paid to the deceased person’s spouse, some or all of their 2.4 children or their estate or a combination. It generally can’t be paid to anyone else (such as a grandchild, sibling, parent) except under special circumstances – for example, if that person was financially dependent on the deceased in some way.
Where there is a surviving spouse or minor children, super is often paid to these beneficiaries because they get the best tax treatment (no tax at all on money taken out as a lump sum) and they are also allowed to take the benefit as a pension. This means the money can stay in super (albeit in most cases children can only do this until they turn 25).
But what about in cases where there is no spouse (perhaps they have already died) and the children are all grown up and financially independent?
The main choice here is whether the benefit should be paid directly from the fund to the (adult) children or whether it should be paid to the member’s estate and paid to the children under the will. Sometimes the will is a bad idea – for example, if the estate has debts or there is a dispute brewing that risks super intended for the deceased’s children landing in the hands of other people.
What about the most common scenarios – where there is no risk in paying the super to the estate and the member is genuinely weighing up all the options before deciding what they want to happen when they die?
The estate is often a great option.
The most well-known benefit is that estates don’t pay the Medicare Levy. That’s great news whenever at least part of the super death benefit amount is going to be taxed (which is virtually all the time if it’s going to adult, financially independent children).
While Medicare is a small percentage (only 2 per cent), remember that it’s applied to capital. That means the amounts can be surprisingly large. A $1 million death benefit which is all classified as being subject to tax will trigger Medicare of $20,000. Who wouldn’t want to save that much if all that’s required is paying the amount via the estate?
A more subtle tax benefit is the impact payments from the estate have (or, more correctly, don’t have) on the calculation of income for a number of important purposes. For example, if a death benefit is paid directly to an adult child it will usually increase the amount of income they report for other things – such as family tax benefits, HELP debts, Commonwealth Seniors Health Card, a special tax on super contributions paid by people earning more than $250,000 known as “Division 293 tax”. By contrast, if they get exactly the same amount but it’s paid via their parent’s estate, it doesn’t count at all.
When the benefit is paid to the estate, it still gets taxed at the same rates as if it was paid directly to the beneficiary (apart from Medicare). But if it’s paid to the estate, the super fund doesn’t have to hold back the tax and pay it to the ATO.
The estate worries about that. This can be extremely useful if, for example, the super fund is an SMSF and it largely owns a property and not much cash. It may not have enough cash to withhold tax from the death benefit unless it sells the property.
But what if the family wants to hang on to the property?
The SMSF could pay the death benefit to the estate in specie (by transferring the property) and the tax bill could be paid from other estate assets. And remember the amounts can be large – a $1m death benefit that’s all subject to tax will generally result in a tax bill of at least $150,000 (possibly more if the deceased was under 65 and had insurance when they died).
Finally, the only way a super benefit will be covered by the person’s will is if it is paid to their estate and wills are much better suited for more complex arrangements. For example, imagine someone who has three children and intends his or her super to be split equally between the three.
What do they want to happen if one of the children pre-deceases him or her?
This is probably catered for in the will but not necessarily well handled in a super fund. In fact, if the intention is to share the child’s portion between his or her own children (the member’s grandchildren), it will generally be impossible to make the payment directly in any case.
As mentioned previously, grandchildren are typically not on the list of approved beneficiaries for super death benefit purposes.
Similarly, estates can provide for testamentary trusts, added protections for vulnerable family members, distributions to other people or entities (charities) that can’t be handled easily (if at all) directly in an SMSF.
All in all, given that the money has to come out of the super environment anyway, there are a great many reasons to consider the estate when it comes to paying death benefits to adult financially independent children.
This story first appeared in the Australian Financial Review on October 29th 2020.