This super strategy can help you avoid the ‘death tax’

Have you ever thought about what happens if you die and still have money in superannuation? Sure, you might hope to spend it all first – but that doesn’t mean you will drain your last dollar perfectly timed for your departure.

Or perhaps it’s your intention to leave some super to your children. The thing is, if your heirs are not also your dependents, you/they will forgo a big chunk of it in tax.

If you’re not careful, your children could be left with less than you think when you pass.Credit: Simon Letch

Super you leave to people who are “tax” dependents at the time of your death is tax-free. This automatically includes your spouse (whether married or not, as well as same-sex) and children under 18.

However, for non-dependents – your children’s status once they become adults – the tax is steep (unless they can prove interdependency): between 17 and 32 per cent – including the 2 per cent Medicare levy.

This will lop off up to a third of your hard-earned savings.

One solution is to – on your deathbed – simply transfer your money out of super. Again, though, timing might be the issue. You don’t always know your moment of mortality, nor will you necessarily be thinking about the tax on your super!

Once your children hit 18, inheritance tax on super is real.

Note that the tax applies only to concessional contributions, or money you’ve put in your fund before income tax. This is because you’ve received a tax concession so, if it’s not going to a dependent, that tax is effectively clawed back.

But concessional contributions include the superannuation guarantee contributions your employer makes, any salary sacrifices you make or any personal contributions for which you claim tax deductions. In reality, they’re probably the bulk of your fund.

Money you put in after tax is called non-concessional – there have been no income tax concessions. With tax already paid, your heirs can usually get the lot. But there is a strategy to preserve for them the concessional contribution component of your fund too: the recontribution strategy.

You essentially take super out then put it straight back in … after tax. You can use a thing called a transition-to-retirement pension to slowly withdraw super and over time reduce the concessional contributions component (your super can tell you the taxed component), and re-contribute the money as non-concessional contributions.

If your heirs are not also your dependents, a big chunk of the super will be lost to tax.Credit: Louie Douvis

The window of opportunity to “tax swap” your contributions via a transition-to-retirement pension starts when you are 60 and ends at 65, the years you are eligible for tax-free withdrawals.

You must still be working and, under the strict rules, must also withdraw between 4 and 10 per cent of your super account balance a year. (The idea of this pension is to let you phase down from work but maintain your income level.)

Alternatively, after you stop work post-60, or after 65, you can take out any amount of super you like and do with it what you want.

On the re-contribution side, you can pay in $120,000 a year after tax (if your balance is under $1.9 million) but also bring forward two years of contributions. That gives the potential ability to pay in $360,000 in one hit.

Due to restrictions on what you can withdraw while you’re working, though, your mission to limit your children’s tax liability might be a slow, concerted process.

Is there a downside to switching your contribution components like this? Yes – you could instead be boosting your super using a transition-to-retirement pension. Another strategy – with that explicit intention – is to use the tax-free income top-up to allow you to make a before-tax salary sacrifice into your super.

In this virtuous tax loop, you can maintain your living money exactly as it is, but squirrel more away for retirement. The catch is that this will, of course, add more money on which your adult children will pay tax.

Taking a step back, how can you ensure, in the first place, that your residual super goes where you want? You need to make a binding death benefit nomination – it’s just a form – with your super fund. And you need to do so every three years. Because in a further trap for your heirs, the forms expire.

If your children are now adults, and you don’t want to use the above re-contribution strategy, it could help from a tax point of view not to nominate them but to leave your super to your will itself.

Specialist outfit Legal Consolidated says you do this by instead writing on your nomination the specific words: “legal personal representative”, which is an official term for the executor named in your will.

But, Legal Consolidated says, you may be able to entirely cut the tax by establishing a superannuation testamentary trust in your will. However, this is a more complex strategy that will require legal advice.

Just know that, once your children hit 18, inheritance tax on super is real.

Nicole Pedersen-McKinnon is author of How to Get Mortgage-Free Like Me, available at www.nicolessmartmoney.com. Follow Nicole on Facebook, X and Instagram.

• Advice given is general in nature and is not intended to influence readers’ decisions about investing or financial products. They should always seek their own professional advice that takes into account their own personal circumstances before making any financial decisions.

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