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Superannuation Testamentary Trust v’s Superannuation Proceeds Trust Super Proceeds Trust
Professor Brett Davies invented Superannuation Testamentary Trusts on 1 May 1994. Superannuation Proceeds Trusts are a poor copy of the Superannuation Testamentary Trust.
Superannuation Death Duties – 17% or 32% tax on your Superannuation at death
When Mum and Dad die, they want to leave money to their children. They spend their superannuation frugally to leave as much as possible in the fund. They nominate their children to get their super. Usually, when you and your spouse die, your children are in their 60’s. At the very least, they are likely to be over 18-years-old. Your adult children are then hit with up to a 32% super death tax. A Superannuation Testamentary Trust or Super Proceeds Trust can reduce that tax down to zero.
Superannuation death benefits are tax-free when paid to tax ‘dependents’ (Tax Dependent – see the table below). But a ‘death tax’ applies to ‘non-dependents’ like adult children. The Australian Taxation Office (ATO) reaps millions of dollars a year from the super death tax.
Death tax rises from the grave thanks to superannuation
By 1983 all Australian States had abolished death duty and probate duty. Before then you had to pay up to 27.9% tax on a deceased estate over $1m.
While probate duties are dead, four defacto death duties have risen from the ashes:
1. Stamp (transfer) duty
2. income tax
3. Capital Gains Tax
4. 32% non-dependency tax
This article considers the 4th defacto death duty. This is the 17% or 32% tax, immediately payable on your death, when your superannuation goes to non-dependants (as defined by the tax legislation, not the superannuation legislation).
Dependents and non-dependents – who is who?
There are two definitions of ‘dependents’:
1. The first is under the Superannuation Industry (Supervision) Act (SISA).
2. The second is under the Income Tax Assessment Act (Tax Act). This is very confusing. Only dependents under the Tax Act avoid the super death tax.
Dependents, as at the moment your death:
|Superannuation Dependant:||Tax Dependent:|
|Your spouse, de facto partner or same-sex couple||Your spouse, former spouse, de facto partner or same-sex couple|
|Children of any age||Only children under 18 years old|
|An ‘interdependency relationship’. A close personal relation, who you live with, where one or both of you provides for the financial and domestic support, and care of the other||An ‘interdependency relationship’ (same definition as superannuation laws)|
|A person who is dependent on you, particularly financially|
2% Medicare: The tax on parts of your Superannuation is 17% or 32%. This includes the 2% Medicare levy. This is if the Superannuation is paid directly to your adult children (rather than into your Will). However, the Medicare levy is not payable if the death benefit superannuation is paid to the Estate (into your Will). This is the case even if the non-dependency tax is payable. Therefore, the non-dependency tax rates through any Will is never higher than 15% or 30%. Of course, if you have a Superannuation Testamentary Trust in your Will then the 15% and 30% tax rates are usually reduced to zero, anyway.
Police officer or soldier killed in the line of duty: This is an exception to the rule. If you get the superannuation from a dead police officer or soldier then you are always treated as a ‘tax dependant’. You, therefore, never pay the non-dependency tax. For example, the soldier hasn’t seen his rich parents for 20 years. The soldier dies in the line of duty. If the super goes to his parents they get it tax-free. As to what is ‘line of duty’ see ITAR 302-195 and Regulation 302-195A. Strangely, such a dead person is not an SIS Dependant. They are only a tax dependent.
How your super money is taxed
A lump sum superannuation death benefit paid to someone who is not a death benefit dependent for tax purposes is subject to 17% or 32% tax. In contrast, lump-sum death benefits paid to someone who does qualify as a death benefit dependent for tax purposes are entirely tax-free. For example, (unless you have a Superannuation Testamentary Trust in your Will) a child over 18 suffers the tax. In contrast, a spouse and child under 18 get the superannuation tax free.
In Superannuation, there are three taxing points:
1. your money may be taxed when it goes in;
2. when it comes out; and
3. taxed on the Superannuation income.
We now consider how the money got into your SMSF fund.
The 2 ways to get money into your Super Fund: Concessional and Non-Concessional contributions
There are only two ways to get money and assets into a superannuation fund. You put in pre-tax dollars (concessional). Or you put in after-tax dollars (non-concessional).
1. If you put pre-tax dollars into your Superfund then the government wants to tax it. The tax rate going in is normally 15%. It can be higher or lower. This is called a ‘Concessional contribution‘. Examples include employer contributions and personal contributions. When you die your adult children usually pay 17% to 32% tax on these concessional contributions (Super Death Tax)
2. Non-Concessional contributions are contributions where income tax has already been paid. You make the contribution them after you have paid income tax. For example, you earn some money and you have $50,000 left after tax. If you put that $50,000 into your Superfund then it is a non-concessional contribution. The money going in is not taxed again. There is no 15% tax on this money. When you die your adult children usually don’t pay the Super Death Tax.
Super Death Tax
While both ‘Superannuation’ Dependants and ‘Tax’ Dependants may get your Superannuation when you die. But only Tax Dependants get the super tax-free. You can pay Tax Dependents a super income stream or a lump sum. You can pay non-dependents a lump sum only. Your Trust Deed or Binding Death Benefit Nomination (BDBN) sets out who receives your money and how. In absence of direction in these documents, your trustee has discretion: Stock v NM Superannuation Proprietary Limited.
Since 2007, superannuation death benefits paid to non-Tax Dependants as a lump sum are taxed:
* Tax-free component of the death benefit is tax-free
* the taxable component is taxed at:
– for the taxed element – a maximum of 15% (plus Medicare); and
– for the untaxed element – a maximum of 30% (plus Medicare)
|Age at Death||Death Benefit||Recipient Age||Tax on Taxed Element||Tax on Untaxed Element|
|Any Age||Lump-Sum||Any Age||0%||0%|
|Age 60 and Above||Income Stream||Any Age||0%||MTR less 10% tax offset|
|Below Age 60||Income Stream||Age 60 and Above||0%||MTR less 10% tax offset|
|Below Age 60||Income Stream||Below Age 60||Marginal Tax Rate (MTR) less 15% tax offset||MTR|
Your Non-Tax Dependents pay:
|Age at Death||Death Benefit||Recipient Age||Tax on Taxed Element||Tax on untaxed Element|
|Any Age||Lump-Sum||Any Age||15% plus 2% Medicare levy||30% plus 2% Medicare levy|
‘Financial dependent’ and ‘interdependency’
When you die your child of any age may receive a lump sum payment directly from your superannuation fund. But, your adult child only receives the taxable component tax-free if they are either:
- your ‘financial dependant’, or
- in an interdependent relationship with you.
Both tests are calculated at the moment of your death.
Obviously, your adult children continue to receive the ‘tax-free component’ of your death benefit tax-free.
If you are a spouse, former spouse or minor child of the dead person then you get the superannuation tax free. For everyone else you need to prove either ‘interdependency’ or ‘financial dependency’:
You and another person (you don’t have to be related) have an interdependency relationship if:
1. you have a close personal relationship; and
2. you live together; and
3. one or each of you provides the other with financial support; and
4. one or each of you provides the other with domestic support and personal care normally.
All the above requirements must be satisfied (except for disabilities). See section 302-200(1) Income Tax Assessment Act 1997.
What about an adult child who moves back in with you – or never left? Simple convenience is not enough. However, caring for an elderly or sick parent ticks the box.
Disabilities: What if you or the dead person, or both of you suffered physical, intellectual or psychiatric disabilities? This doesn’t bar you having an interdependent relationship. For example, an adult disabled son’s super goes to his mum and dad, via his estate. While his parents are not ‘financial dependants’ they may be ‘interdependent’.
If you or the dead person suffers from a disability then you only need to satisfy ‘close personal relationship’. This is without meeting the other requirements if the reason they are not satisfied is that either of you suffers from a disability.
Temporarily apart: An interdependency relationship criteria is also met if you have a close personal relationship but are temporarily living apart. See section 97 302-200 ITAA and ITAR 97 section 202-200.02.
For interdependency, there is no requirement that the dead person provided any financial support.
2. Financial Dependent
To prove this the adult child needs to be relying on the dead person’s money.
To make the point clear, this is not about you giving financial support to the dead person. This test is only about the dead person giving you financial support.
You would have thought this is easy to prove as parents tend to dote on children until the day we die. However, to try and close this loophole the ATO takes a narrow view:
* was the person ‘wholly or substantially’ maintained financially by you?
* if your financial support was withdrawn, would the person survive?
* does your financial support merely supplement the person’s income?
* is the financial support merely for a higher ‘quality of life’?
* could they meet their daily needs and basic necessities without your additional financial support?
* is there reliance on regular and continuing financial support for day-to-day living requirements?
* what receipts for expenditure and evidence do you have for living expenses.
The ATO has a very hard time disputing what you tell them. Unlike George Orwell’s book Nineteen Eighty-Four the ATO does not have cameras set up in your home (well not yet). So the ATO has no idea what happens in the privacy of your home.
Also the above is the ATO’s view on what is ‘financial’. The Court’s view is different. The Court’s view prevails over public servants such as the ATO.
You calculate the super death tax using the proportioning rule.
How the Proportioning Rule works
Step 1: Work out the tax-free and taxable components of the super interest just before the lump sum was paid.
Mary started working on 10 August 1076. She would have turned 65 on 1 July 2017. Sadly, Mary dies on 1 July 2014. Her superannuation fund comprises $400k, 25% that is tax-free and 75% that is taxable.
The lump-sum is $280,000. The tax-free component is $70,000 (25%). The taxable component is $210,000 (75%). Mary leaves her money to her darling daughter Lucy.
Step 2: Calculate the taxed element. This is: ( Lump sum x Service days ) / ( Service days + Days to retirement )
The number of service days, between the date Mary started working and the retirement date, are 13,841. She had 1,095 days to retirement when she died.
Applying the rule: ( $280,000 x 13,481 ) / ( 13,481 + 1,095 ) = $259,472.
Less the tax-free component: $259,472 – $70,000 = $189,472.
The total taxed element is $189,472.
Step 3: Calculate the untaxed element.
The taxable amount less the taxed element is:
$210,000 – 189,472 = $20,528.
Therefore, the untaxed element is $20,528. Lucy pays this as tax to the ATO.
How to avoid an after-death tax experience
Here are some ways to keep your money out of the super death tax trap:
1. Don’t die (we understand that medical science is working on this).
2. Ensure you create a beneficiary that qualifies as a dependent for income tax purposes (Tax Dependent). This is at the time of your death. Put in a Superannuation Testamentary Trust in your Will.
3. Ensure 100% of your benefits form part of the tax-free component.
4. Have nothing inside your superannuation fund at the time of death.
The simplest solution is to leave your super to your Estate and put a Superannuation Testamentary Trust in your Will.
Whether a person is a ‘dependent’ for tax purposes is a question of fact. We judge every case on the facts. However, from our experience, we know that you can pass on your money tax-free by:
1. Speaking to your accountant and financial planner. Make sure your super gets into your Will.
3. Having your Tax Dependents in your Superannuation Testamentary Trust to receive the capital amount. If you are worth under $10M, then paying your grandchild’s private school fees of $20,000 every second year would generally make that grandchild your dependent. The trust capital does not need to be paid out for 80 years from the date of your death. In the meantime, your children direct the income from the superannuation to themselves. If there is any money left after 80 years, it goes to your grandchild (or their family if dead).
4. In summary, the Tax Dependent is decided at the moment of your death. Let’s say it is one of your grandchildren. In 80 years that grandchild gets the capital. In the meantime, the income is not subject to the Superannuation Death Tax. The income is distributed as per your children’s direction as controllers of the Superannuation Testamentary Trust. Only the capital left in 80 years from the date of your death goes to that grandchild.
Here is a problem one of my clients had:
Dad is a widower. He has $2M in his Super Fund. All his super was contributed concessionally. That is, he put in his Fund pre-tax dollars.
Dad’s three children are all over 18 years of age. They no longer live in the family home. They are not dependent on him, although they do come over for dinner regularly. His oldest son has a daughter, Estelle. She is an angel. She is Dad’s only grandchild.
Dad wants to leave an inheritance to his children. But his financial planner tells him that, at death, his children will pay over $323,000 in non-dependency tax on his Super.
– prepares a Will containing a Superannuation Testamentary Trust
– signs a non-lapsing death benefit nomination to the estate (so his super goes into his Will), and
– writes a cheque for granddaughter, Estelle’s private school fees each year
With all his affairs in order, Dad dies peacefully.
His superannuation is directed to his Will (‘legal personal representative). There is a Superannuation Testamentary Trust in his Will. A ‘dependent’ for tax purposes is calculated at one time. This is at the exact moment of Dad’s death. Dad had one dependent for tax purposes, Estelle.
The whole of the $2M of super goes to Estelle, but it is only payable in 80 years’ time. In the meantime, Dad’s children use a third of the superannuation’s income each.
If there is any money left in 80 years then that remaining capital goes to Estelle.
What is the yearly income tax rate once super gets into my Will?
The above issues are about not losing 1/3rd of your super at death. Let’s now look at the income tax payable each year on the assets that go into your Will.
When you distribute trust income to a minor their tax rate is penalty 66%: Division 6AA Income Tax Assessment Act 1936. But thanks to Section 102AG for any beneficiary under 18 years of age (including children and grandchildren) the tax rate is the same tax rate as an adult. This is if you have a:
- 3-Generation Testamentary Trust Will
- Superannuation Testamentary Trust in your Will
This is another advantage of having super go into your 3G Testamentary Trust Will.
But Section 102AG(2AA) was amended in 2020. This was because:
… some taxpayers are able to inappropriately obtain the benefit of this lower tax rate by injecting assets unrelated to the deceased estate into the testamentary trust. This measure will clarify that minors will be taxed at adult marginal tax rates only in respect of income a testamentary trust generates from assets of the deceased estate (or the proceeds of the disposal or investment of these assets).
The Explanatory Memorandum (‘EM’) further states:
1.13 … These requirements are directed at ensuring that assets unrelated to the deceased estate cannot be injected into the testamentary trust and derive income that is excepted trust income for the purposes of Division 6AA. That is, the requirements ensure that there is a connection between the property from which excepted trust income is derived and the deceased estate that gave rise to the testamentary trust.
Example 1.1 Injected asset
On 1 July 2019, testamentary trust ABC is established under a will of which a minor is a beneficiary. Pursuant to the will, $100,000 is transferred to the trustee from the estate of the deceased. Shortly after the testamentary trust is established, a related family trust makes a capital distribution of $1,000,000 to the testamentary trust. The resulting $1,100,000 is invested in ASX listed shares on the same day. Dividend income of $110,000 is derived for the 2019-20 income year. The net income of the trust is $110,000 and the minor is presently entitled to 50 per cent of the amount of net income.
The minor’s share of the net income of the trust is $55,000. $50,000 is attributable to assets unrelated to the deceased estate and not excepted trust income. $5,000 is excepted trust income on the basis that it is assessable income of the trust estate that resulted from a testamentary trust, derived from property transferred from the deceased estate.
Therefore assets unrelated to the deceased estate cannot be injected into the testamentary trust. We are of the view that has always been the law. Our Wills comply with these rules.
Questions about Superannuation Testamentary Trusts
Q: What is the tax rate on the income earned on the Superannuation benefit over that 80 year period?
* The income earned on the capital is, of course, subject to normal income tax. The marginal tax rate payable is as per the person receiving the income.
* There are additional benefits as the superannuation is part of the deceased estate. Normally, a person under 18 years of age pays tax at 66% under Division 6AA ITAA 1936. This is a penalty tax rate for minors getting unearned income.
* However, because the Superannuation is now part of a testamentary disposition the penalty child tax rate does not apply: section 102AG ITAA 1936. Instead, minors pay tax as if they were adults. This is good news. E.g. if you have 10 great-grandchildren under 18 years of age then you can absorb over $200,000 of income, each year, without paying any income tax.
Q: Any tax obligations on the Tax Dependent – either now or in 80 years?
* The Tax Dependent has no taxation obligations – either now or in the future. To labour the point, in 80 years time, if there is any capital left it goes to the Tax Dependent or, more likely, their next of kin for no tax.
Q: How do you prove that a person is a Tax Dependent?
* It is always a question of fact as to whether you die leaving behind a ‘spouse’, ‘de facto’, ‘interdependency’ or ‘financial dependent’. This is decided at one point in time – the moment of your death. There is no rule. The Courts look to each set of facts with fresh eyes. As to ‘financial dependency’ a rough rule of thumb is that if you are worth under $10m then paying a grandchild’s private school fees of $20k every 2nd school would probably make that grandchild a Tax Dependent. (You only need one Tax Dependent to reduce the Super Death Tax to zero – provided you have a Superannuation Testamentary Trust in your Will). Where your accountant, lawyer or financial planner wishes more certainty then we can provide a comprehensive letter of advice setting out the facts, law and conclusions:
1. before you die, we sign off to say that, based on the facts, that you have done what is necessary to create a Tax Dependent; or
2. after you die, establish and collect the necessary evidence and sign off on the existence of the Tax Dependent.
Q: Extend the 80 year vesting period?
Australian trusts only last 80 years. (SA doesn’t have the 80-year rule, but any beneficiary can direct the trust be vested in that State). After 80 years they must vest. More information here.
Q: What if the Tax Dependent dies before the trust vests? Dealing with trust capital.
The capital of the trust is unlikely to last 80 years. There is no requirement to invest the capital in appreciating assets. For example, you may purchase depreciating assets like boats and cars. But whatever is left after 80 years vests in the Tax Dependent. Usually, the Tax Dependent would have died from old age. Therefore, the capital goes according to the Tax Dependent’s Will or next of kin.
Q: How do I prove ‘financial dependency’?
There is no hard rule as to what is required to satisfy ‘financial dependency’. It is a question of fact to be decided in each case. For example, if the person you are supporting is poor, then not much financial support is needed. If the person is rich then you need to give them a lot more money to prove that they are financially dependant on you. Another factor is the financial support is for the necessity of life.
These tests appear to imply that only the necessities of life are relevant. For example, in Private Binding Ruling 64085 the dead granddad paid for social outings, medication, pocket money, chocolate, music, CDs and costs for football for a grandchild. It was not enough to establish financial dependency. (Many would argue that football and chocolate are necessities of life!)
Similarly, in PBR 40376 the money spent “tended to be on luxury items such as entertainment, rather than the child’s day to day living expenses”. In this example, financial dependence was not made out.
That is why supporting grandchildren and their private school fees work well. In Private Binding Ruling 52530, the payment of school fees, along with payment for necessary food, shelter and clothing, was enough to prove that the child was dependant on the dead person. Generally, if the grandchild and his parents are worth under $5m then the payment of school fees to one of the grandchildren every second year would be enough to prove financial dependency.
Hint: Regularity and continuity are important for financial dependency. The ATO requires that you show reliance on regular and continuous contributions. The dependant shows that they received financial or substantial help from the dead person. This is to meet their “basic” needs. (Whatever that means from one generation to another.) This is over a regular and continuous period. The trustee of the superannuation fund needs evidence to make a decision. Financial dependency is harder to prove if you are rich. A rich person doesn’t need money for the ‘necessities of life’.
Remember, the ATO is keen to get back death duties in Australia. It goes out of its way to argue that there is no financial dependency. Haven’t said that in the 100s of disputes we have had with the ATO on this matter we have never lost a financial dependency or interdependency argument. The ATO knows it is not a solid ground in their arguments, but so few people are willing to take the ATO on.
Does the Superannuation Trustee hold and pay the 17% or 32% tax to the ATO?
If the Superannuation fund is paying the super directly to a person then the super fund decides if the person is a ‘tax’ dependant. However, if the super fund is paying it to the estate then it doesn’t have to address its mind to this question.
Otherwise, if the super gets into the Will then the Executors must give thought to this.
What if the Superannuation Trustee or the Executor in the Will decides that the person is a ‘non- tax dependant’? It holds back the 17% or 32% tax (or 15% or 30% for the estate) and sends it to the ATO.
When it doubt any of the parties can approach Legal Consolidated for advice on the matter.
What can you do about your super?
Work with your accountant and financial planner. Reduce the Super Death Tax to zero. Consider superannuation as part of your broader estate planning. If you don’t, the ATO is the grim reaper at your death.
Quiz on superannuation death taxes
Q 1: Is Super an estate asset?
Q 2: When I complete my Binding Nomination do I put in the name of my executors in my Will?
Q 3: The last update of my SMSF Deed was more than 5 years ago. Do I need to update it again so that my Death Benefits Nomination is binding?
Q 3: Can I leave me super directly to anyone I want?
No. Your Super can only go to spouses/defactos, your children, financial dependants and interdependent. (And tax [free] dependants do not include adult children.)
Q 4: But I want to leave my super to my brother, friend, parents and Church.
A: Well, in that case, get the super into your Will (see above). And then you can leave your super to whoever you want.
Q 5: What are the only two ways that super can be paid out to the lucky person or Will at death?
Superannuation death benefits are paid as a lump sum or income stream. A death benefit cannot be retained by a beneficiary in the accumulation phase.
Q 6: Can anyone take an income stream?
A: Only certain dependants receive a death benefit income stream. They are a more limited group: spouse, financial dependant and interdependents. (But your child must be under 18, under 25 if financial dependant on you at the moment of your death, or older with a disability.
Q 7: At what moment of time do you decide if the person is a dependant for superannuation and tax purposes?
A: At the moment of your death.
For help building a 3-Generation Testamentary Trust on our website please telephone us.
Legal Consolidated Barristers and Solicitors
Nationwide Australian law firm
Email: [email protected]