By Monica Rule

I recently met an elderly SMSF trustee who was convinced that his adult son, who is not financially dependent on him, would receive all his superannuation savings (consisting of the tax-free component and taxable component) upon his death totally tax-free.  The trustee thought that because his adult son is classified as a “dependant” under the superannuation law, he would receive the benefit tax-free.   

He was wrong!

You see, as his son is not a “death benefit dependant” under the income tax law, he will not receive the taxable component of his father’s superannuation savings tax-free.
The way the superannuation and income tax laws interact can be confusing. SMSF members who don’t understand the law could end up leaving their loved ones with a big tax bill.  In this article, I will explain how the superannuation and income tax laws impact on death benefits.

The superannuation law states who can be paid a death benefit upon the death of an SMSF member, while the income tax law states how the death benefit will be taxed, based on who receives it, and whether the benefit is paid as a lump sum or an income stream (i.e. pension). It is important to note the two laws also differ on the definition of a “dependant”.  

Under the superannuation law, a “dependant” is a spouse by marriage or a de facto partner (including same-sex partners), and a child of any age.  It also includes anyone who had an interdependent relationship with the deceased.  An interdependent relationship is where two people (whether related or not) have a close personal relationship and live together and provide financial or domestic support and personal care. The superannuation law also states that a death benefit pension can only be paid to the deceased member’s dependant and in the case of a child it can only be to a child who is less than 18 years of age, or is aged 18 to 24 and was financially dependent on the deceased before their death. A child of any age with a disability is also eligible. 

Under the income tax law, a dependant in relation to a death benefit is referred to as a “death benefit dependant”. A death benefit dependant can be the deceased’s spouse by marriage or a de facto partner (including same-sex partners), a child under the age of 18, or a person who is financially dependent on the deceased person before they died.  It also includes a person with whom the deceased person had an interdependent relationship with just before their death. Unlike the superannuation law, the definition also includes a former spouse.

A person classified as a dependant under the superannuation law can receive an SMSF member’s death benefit in accordance with the deceased’s SMSF trust deed and/or as per the deceased’s binding death benefit nomination.  People who do not meet the definition of a dependant (for example: siblings, grandchildren, parents, friends) under the SISA can only receive the deceased’s superannuation via the deceased’s estate (in accordance with the deceased’s will) through the deceased’s legal personal representative.

Gold and Platinum Members please read on for information on a binding death benefit nomination.

The tax treatment of a death benefit depends on who receives the benefit and whether the benefit is paid as a lump sum or a pension.  If the recipient of a death benefit is classified, under the income tax law, as a death benefit dependant and receives the benefit as a lump sum, then regardless of the components of the lump sum, the entire death benefit is tax-free.

If the recipient who received the lump sum death benefit is not classified as a death benefit dependant, then while the tax-free component of the lump sum will still be tax-free, the taxable component of the lump sum will attract tax at the maximum of fifteen (15) per cent plus the Medicare Levy.

The tax treatment of a death benefit pension depends on the age of the deceased, the age of the recipient and the components of the pension. If the benefit is paid to a death benefit dependant, and either the recipient or the deceased are over the age of 60, then both the tax-free and taxable components of the pension will be tax-free.  If, however, both the dependant and the deceased are under the age of 60, then the taxable component of the pension will be taxed at the recipient’s marginal tax rate with a fifteen (15) per cent tax offset.

Trustees should also bear in mind that under the superannuation law, the death of an SMSF member will trigger a compulsory payment situation.

Gold and Platinum Members please read on for information on when a death benefit must be paid.

Monica Rule is an SMSF Specialist and author – www.monicarule.com.au

Related documents:

• Self Managed Superannuation Fund Deed
• SMSF - Deed Update
• Pension Pack for Self Managed Super
• Build a Company (Elodgement)