How to make sure your kids avoid a huge tax bill after you die

Inherited funds from super savings accounts get a 17 per cent tax bill, but there’s a way to avoid it entirely. Here’s how.

Inherited funds from super savings accounts get a 17 per cent tax bill. Picture: iStock

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There’s a common misconception that Australia doesn’t have an inheritance tax.

But the reality is that most people who inherit super will face a 17 per cent tax bill.

And keeping in mind there is now $4.2 trillion in super savings accounts, those tax bills are big and getting bigger every year.

“There’s going to be a lot of wealth transferred in the near future with money coming out of super and tax on super is definitely on the spot for many people,” financial adviser and lawyer Chris Hill told The Australian’s The Money Puzzle podcast.

Smart investors who have significant funds in super, which they know will some day be a key part of their estate, are not standing still.

Mr Hill, the co-founder of Inherit Australia, said contributing to super is now a very popular strategy.

In the past, the recontribution strategy in super was a relatively arcane activity pursued only by the most tax-obsessed Australians, but now with universal super savings, it’s steadily going mainstream.

The 17 per cent tax on inherited super applies on money that received tax concessions in the past, which turns out to be the vast majority of super savings.

And it is imposed on non-dependants such as adult children, who represent the vast majority of those inheriting super.

But the 17 per cent tax bill can be avoided, or at least substantially reduced, through the recontribution strategy,

So how does it work?

Financial adviser Hugh Robertson, chief executive of Centaur Financial Services, said a recontribution strategy, which involves withdrawing part of your superannuation fund balance then paying it back into the account, may sound strange but it can reduce tax and help manage super balances between yourself and your spouse.

Centaur Financial Services CEO Hugh Robertson.

“Recontribution strategies can be very helpful for estate planning, particularly if you intend to leave part of your super death benefit to someone who the tax law considers a non-tax dependant, such as an adult child,” Mr Robertson said.

The essence of the strategy is that you take money out of super tax-free and then put it back in, which is also tax-free. In technical terms it means making a tax-free withdrawal and then afterwards making a non-concessional contribution with the same money.

There are some conditions around using recontribution strategies, the key rule relates to age. The super saver must be between 60 and 75.

And the strategy can take time to enact since there are limits on how much money can be contributed into super each year. The current limit is $120,000 per annum.

Over a period of time with successive adjustments, the taxable component continually shrinks.

That’s how you can whittle down the taxable amount in your super inheritance, or if you are very fortunate, you may be able to eliminate the taxable component completely.

Mr Hill told The Money Puzzle that the super that will be taxed is “basically any money that you’ve put into a superannuation fund including your super guarantee payments where there has been a tax deduction claimed that forms part of the taxable amount”.

If you work just about anywhere in Australia then you must, by law, contribute to super.

Contributions are taxed at 15 per cent before going into you account, rather than at your marginal rate which could be as high as 45 per cent.

Many years later the government wants that original favour repaid.

With the recontribution strategy you can reduce the bill your adults kids are going to get from the Australian Taxation Office due to that long ago favour, and for an increasingly number of investors it’s worth the effort.