At death super is exposed to an effective inheritance tax but there are ways to minimise the hit

The next generation can inherit your super but with it can come a tax slug too. Here’s how to make sure as much money as possible flows to the people and places you want.

The next generation can inherit your super but with it can come a tax slug too.

The 200-year-old quote attributed to US statesman Benjamin Franklin regarding death and taxes still holds true today.

In fact, taxes do not stop when we die and, depending on how our assets are structured and who we leave them to, there can be even more taxes to pay from the afterlife.

Given the choice, most people would prefer that as much money as possible flow to the people and places they want, as opposed to boosting the government coffers after they die.

Although not commonly known by retirees, with some foresight and careful planning there are steps that can be taken to legally minimise taxes triggered upon death on superannuation accounts.

Overseas there are some countries which have quite aggressive inheritance tax systems in place. The United Kingdom levies a 40 per cent tax payable on assets above £325,000 left to anyone other than a spouse, a charity or a community amateur sports club.

Although we do not have anything like this in Australia, it is still common for taxes to be paid after we die. Specifically, capital gains tax is paid by our estate on the sale of investment assets such as investment property and shares.

Superannuation is a little more complex as the tax treatment depends on who we leave it to.

If you leave your super to someone classified as a “death benefit dependant”, the whole super balance is paid tax free. People who fall under this umbrella include your spouse or a de facto, children under the age of 18 and other people who are financially dependent on you.

If super is paid to anyone outside of this group, then part of the super balance, known as the taxable component, is subject to 15 per cent tax plus 2 per cent Medicare levy. The taxable component consists of pre-tax super contributions such as employer superannuation guarantee contributions and salary sacrifice amounts.

What normally happens in the typical family situation is that when one elderly parent dies, their super is transferred to the surviving spouse tax free. It is only at a later point when the surviving spouse also dies that the taxing event occurs.

The superannuation account is usually left to adult children and grandchildren who usually do not meet the definition of being a “death benefit dependant”. This is where the 17 per cent tax comes in.

The strategy to reduce this tax comes down to having a good understanding of the broader superannuation framework and working within its parameters to your advantage. If you are retired and over the age of 60, you can commence an account-based pension up to $1.9m tax free. In other words, there is no tax on the earnings, gains or withdrawals.

And there we have it – no tax on withdrawals. Although there are minimum pension payments which need to be taken each year, starting at 4 per cent under the age of 65 and up to 14 per cent when over 95 years of age, on the flip side there is no maximum pension payment cap.

This means that 100 per cent of your superannuation benefit can be withdrawn at any time in retirement.

Although not pleasant to think about, the reality is that if you know that your remaining time is limited, you could consider withdrawing 100 per cent of your superannuation account balance tax free, then transferring the funds to your intended beneficiaries such as adult children and grandchildren, which is sent and received tax free.

Legal advice is recommended as making the pre-death inheritance can lead to potential legal issues if your estate is challenged, particularly in NSW where there is the concept of “notional estates”. Simply put, people who feel they should have been entitled to some of your super money can lodge a claim against your estate and request that withdrawn super funds get clawed back.

Aubrey Brown Lawyers estate planning practitioner Peter Kernan says: “This concept also applies to other assets that may have been sold or transferred within up to three years prior to death.

“The Supreme Court can make an order that the relevant superannuation withdrawal or asset sale can be reversed, thus bringing that asset back into the estate for division among beneficiaries.”

Other considerations include whether it is a good time to sell down your super account with regard to investment market conditions, and also whether it is a good idea to hand a potentially large sum of money to your children and grandchildren, as opposed to letting the money flow through your estate to a testamentary trust which can drip feed money out.

Of course not all of us can plan when we are going to die. But if there is time, then triggering a strategy to clear out the super fund and pass it on to family prior to death can be a tax-effective way to transfer wealth from one generation to the next.

James Gerrard is principal and director of Sydney financial planning firm www.financialadvisor.com.au