"Simpler Super" changes to Death Benefits - the so called "Death tax"

'Simpler super', due to commence on 1 July 2007, will change the rules about the form in which death benefits can be paid and about the way they are taxed. Some people are calling the new rules a 'Death tax'. Julian Smith explores the changes and discusses the implications for advisers and their clients. Also, you can watch the video of Cleardocs' interview (and related commentary) with ATO Assistant Commissioner, Stuart Forsyth.
 

The relevant rules

In general, the payment of superannuation benefits after a member's death (Death Benefits) are governed by:

  • any binding or non-binding death benefit nominations the member made;
  • the Fund's trust deed;
  • superannuation law - which sets out to whom death benefits may be paid; and
  • tax law - which determines how those benefits will be taxed.

Under the new rules, death benefits may still be paid only to superannuation law 'dependants' (SIS Dependants)1.

The changes

The new laws have changed:

  • the form in which death benefits can be paid; and
  • how they will be taxed in the hands of the recipient.

Some people are referring to the new arrangement as a "death tax". However, (as is explained below) the new arrangement:

  • is more generous to taxpayers than the old system; and
  • has not introduced any news taxes at all.

Death benefit paid as a lump sum - the new tax rates

If a death benefit is paid as a lump sum to a SIS Dependant:

  • who is a Tax Dependant,2 then both the tax free component (made up of amounts such as undeducted contributions, pre-1983 contributions and so on) and the taxable component of the lump sum are tax free.
  • who is not a Tax Dependant, then the tax-free component remains tax-free but in relation to the taxable component:
    • tax is payable at 15% on that part of the pension that is funded by elements of the SMSF's assets on which tax has been paid, and
    • tax is payable at 30% on that part of the pension that is funded by elements of the SMSF's assets on which tax has not been paid.

Death benefit paid as a pension

Who can the pension be paid to? A death benefit paid as a pension may only be paid to a SIS Dependant. If the dependant is a child of the member, then the dependant must be both under 25 and financially dependant (this is a Pension Dependant3);

When must a death benefit pension convert to a lump sum? If a death benefit is paid as a pension to a child, then is must convert to a lump sum as soon as the child either becomes dependant or turns 25.

How is the pension taxed? Remember, the tax free component of the assets used to fund the pension will remain tax-free. The tax payable on the taxable component depends on the member's age when they died, the age of the receiver and on whether tax has been paid on the SMSF's assets used to fund the pension.

For a member who died aged less than 60:

  • tax is payable at 15% on that part of the pension that is funded by elements of the SMSF's assets on which tax has been paid, and
  • tax is payable at the receiver of the pension's marginal rates on that part of the pension that is funded by elements of the SMSF's assets on which tax has not been paid. (When the receiver turns 60, the tax treatment changes to the system described in the next paragraph.)

For a member who died aged 60 or more:

  • no tax is payable on that part of the pension that is funded by elements of the SMSF's assets on which tax has been paid, and
  • tax is payable at the receiver of the pension's marginal rates on that part of the pension that is funded by elements of the SMSF's assets on which tax has not been paid. Also, there is a 10% offset on the tax rate which means that if the receiver was in the top marginal tax rate they would only pay tax at 36.5% (46.5% less 10%).

How is the new system more generous than the old system?

The new rules are more generous than the old rules because, for example, under the old rules a lump sum death benefit paid to a Tax Dependant is tax-free only up to the member's pension RBL.

So why are people calling it a "death tax"?

People are referring to the new system as a "death tax" because of the contrasting tax treatment:

  • of amounts paid directly to the member when they are alive, and
  • amounts paid to non-Tax Dependants (for example, an independent adult child) after the member's death.

How should people plan for the new system?

The sudden change for the worse in tax treatment after a member dies highlights the need to plan, as far as possible, for clients who are in or nearing retirement - or whose death may be close. Advisers need to be vigilant in:

  • advising clients when they retire about the tax implications set out above;
  • regularly revisiting these implications with clients - particularly those who have been diagnosed with a serious illness; and
  • reviewing arrangements in respect of clients' powers of attorney, and whether they enable a trusted person to control the client's affairs if a client loses the capacity to do so.

However, advisers need to be wary of creative strategies to avoid taxes otherwise payable on death benefits. For example, it is inappropriate to set up an arrangement that deems a member's death to have triggered a benefit payment decision to have been made by the member before their death. An arrangement like that would be merely an attempt to avoid tax - and so would give rise to likely penalties etc. under Part IVA.

One appropriate strategy would be to have a member take as much of their super as possible in view of the member's tax position. Members can't withdraw too much from super because, once outside super, earnings on that money is taxed. So the idea would be to take out as much as is possible while still ensuring tax on earnings on the money taken out has a negligible effect on how much total tax the member has to pay.

What is the ATO saying?

Advisers should monitor any ATO commentary about death benefits. For an insight into the ATO's current state of mind, you may wish to view the comments of ATO Assistant Commissioner, Stuart Forsyth at Cleardocs' March 2007 Business Insights Breakfast.

More information

For more information in relation to this article, please contact Julian Smith on 02 9288 0555.

For superannuation inquiries generally, please contact Maddocks and ask for a member of the Maddocks Superannuation Team either:

  • in Melbourne on 03 9288 0555 or
  • in Sydney on 02 8223 4100.

1 As defined by section 10, Superannuation Industry (Supervision) Act 1993
2 As defined by section 302-195 the Income Tax Assessment Act 1997
3 As defined by regulation 6.21(2A), Superannuation Industry (Supervision) Regulations 1994