While superannuation lump sum payments to dependants upon a member’s death are tax free, it can be difficult to decide how to invest the amount received. As an alternative, an overlooked strategy is to have the death benefit paid as an income stream. The decision to receive a death benefit as a lump sum, income stream or a combination always depends on the circumstances.
Superannuation law permits payment of benefits upon the death of a member to certain dependant(s) as a lump sum, income stream, or a combination of both. The payment of death benefit income streams from superannuation are restricted to:
- spouse of the deceased (de facto or same sex);
- children under 18;
- children aged up to 25 who were financially dependent upon the deceased; or
- children with a qualifying disability.
The ability to pay a lump sum, income stream or a combination of both provides flexibility to meet the needs of the recipient(s). However, care is required when choosing a super fund that can pay death benefits as an income stream. Not all funds are able to pay death benefit pensions and many will simply pay lump sums.
One of the advantages of a death benefit income stream is the tax-free treatment of earnings on investments funding the income stream. In comparison, income and capital gains on investments held outside of superannuation are taxed at personal tax rates.
Death benefit income streams receive concessional tax treatment. If the deceased or beneficiary is age 60 or over, pension payments are tax free. If both the deceased and beneficiary are under age 60, taxation may apply. The tax-free component is received tax free and the taxable component is taxed at the recipient’s marginal rates. However, a 15 per cent tax offset applies to the taxable component to help reduce the amount of tax payable.
Death benefit pension payments to minors upon death are treated as ‘excepted income’ and taxed at adult tax rates, not the penalty rates for unearned income of minors.
Death benefit income streams retain funds in super. Keeping funds in super avoids issues when lump sum payments are made, when an individual is restricted from contributing to super. Some restrictions include eligibility to contribute to super for those above 65 years of age and contribution cap restrictions.
Superannuation law does not allow payment of death benefit pensions to an estate. It is therefore important that a qualifying dependant is nominated, otherwise the ability to pay an income stream may be jeopardised. Qualifying dependants, such as a spouse, can be nominated as a reversionary beneficiary at the start of the pension. The benefit of a reversionary pension is that the funds are retained in super.
Care also needs to be taken when making the death benefit nomination. Many super funds will permit two different types of nomination, binding and non-binding.
If a valid binding nomination is made, the super fund will be obligated to pay the death benefit to the nominee and/or their estate. This type of nomination is generally required to be renewed every three years. As such, it is important to review the client’s position regularly.
By contrast, a non-binding nomination provides direction to a super fund but does not require them to pay the death benefit to the nominee and/or their estate. This type of nomination will only need to be reviewed after a major life event, such as divorce. Some super funds will treat valid non-binding nominations as binding. They often refer to them as a ‘non-lapsing binding nomination’.
It is important to understand that while a super fund can be bound as to who receives the death benefit, most won’t be bound as to how it’s paid. You will need to make sure the super fund is willing to pay the death benefit as an income stream upon request.
Care is needed in assessing whether super benefits should be taken wholly or partially in the form of an income stream. ‘Anti-detriment’ payments are only payable on lump sum payments and not pensions. Generally, anti-detriment payments increase a lump sum super death benefit by effectively ‘refunding’ the contributions tax that previously applied to the member’s super benefit.
There are many variables applying to the payment of superannuation death benefits. Ultimately, how a benefit should be paid will depend on a client’s circumstances. Consideration of a payment wholly or in part as an income stream(s) may help to provide a better outcome by taking advantage of the concessions provided.
Matt Hughes is technical services manager at ING Australia.
