Inheritance tax trap: How to avoid creeping tax bills on super, but it’s all about timing

Growing awareness of the 17 per cent tax trap inside super has advisers working overtime on investment strategies, including the complete withdrawal of funds.

Creeping inheritance tax bills are a hidden risk in the tax system, experts say. Artwork: Emilia Tortorella

Creeping inheritance tax bills on super are being described as a hidden risk in the tax system.

With an increasing number of Australians heading for an unexpected 17 per cent tax bill when they inherit super, advisers are spelling out investment strategies to avoid such bills in the future.

Savvy investors use a so-called recontribution strategy to reduce the taxable component of the inheritance left behind in super accounts. But advisers also suggest a more aggressive approach, which is simply to take all money out of super in a timely fashion to distribute to intended beneficiaries.

A new report from Wilsons Advisory tells investors inheritance tax in super is a hidden risk inside a $3.5 trillion intergenerational wealth shift taking place across the market.

The advisory firm says “unintended tax liabilities can be incurred if superannuation is not adequately prepared in advance”.

According to the Wilsons Advisory Generational Blueprint report, a 17 per cent tax on super can be avoided if a parent closes the super account and withdraws all funds as a lump sum.

“Without a strategy, families may be forced into avoidable asset sales,” the report says.

Advisers suggest both recontribution strategies and the more aggressive withdrawal strategies are feasible for investors over 60, but the contrasting moves have different outcomes.

Recontribution strategies keeps money inside the tax-protected superannuation system and the portion of money that is recontributed is no longer liable for the 17 per cent super inheritance tax.

Meanwhile, money withdrawn from super as a lump sum will not be exposed to any de facto death tax since Australia does not have an official inheritance tax.

However, once outside the super system, the withdrawn funds are exposed to a variety of new taxes at rates which may be higher than superannuation, where earnings on amounts up to $2m are tax-free.

“The inheritance of super is an area where we are seeing more traction as the amounts become more significant,” says Paul Aliprandi of Wilsons Advisory.

“It shows that people should ideally be pre-planning for these outcomes.”

The subject of inheritance tax in super is becoming a bigger issue because it’s starting to affect more people. The amount that you must put into super by law increases each year. This amount, known as the superannuation guarantee charge, goes into your super account with a tax concession. When it comes out the other end as inheritance, the government demands that the initial concession is refunded.

Advisers have long recommended both recontribution and withdrawal strategies to wealthier clients with self-managed super funds. Both strategies are also open to investors in big super funds, however the process will inevitably take longer to conclude as fund members will need to deal with big funds directly to enable the transactions to take place.

Big super funds have already been in trouble this year over delayed death benefits payments, with regulator ASIC producing a report that said delays at the funds were unacceptable.

The challenge with both strategies is timing. The super investor needs to find a balance between the funds they require and the funds they are prepared to distribute pre-inheritance.

More than 700,000 Australians are due to retire with the next five years.

As a result, super and inheritance taxes are in the frame as the government prepares for its economic roundtable later this month.

Among the key issues on the agenda will be death taxes along with a possible crackdown on family trusts.

There is also speculation there will be a reduction in capital gains tax benefits. At present, CGT taxpayers receive a 50 per cent discount once an asset is held for more than 12 months. There is speculation this discount could be reduced 25 per cent.