(03) 9020 2905PORTFOLIO POINT: If you don’t know what day you’re going to die, a little forward planning for your super assets is an imperative.
When the Howard Government made super tax free for the over 60s, it might have appeared like all you had to do was reach that age and everything from that point was untouchable from the likes of the tax office.
While you remain alive – and unless governments overturn Peter Costello’s reforms – that’s largely the case.
The problem is death. While dying is usually a reasonably severe disappointment to the person who has ceased to breathe, those that they have left behind can be in for a nasty shock on the inheritance front if some proper planning hasn’t been used to neutralise taxation consequences, as much as is possible.
An unfortunately timed earthly exit can, sadly, turn your tax-free pile of cash into something that can be quite heavily taxed.
Even if you’ve been enjoying life as a pensioner paying absolutely no tax, or very little, for an extended period of time, your death could lead to as much as 46.5% of the sum being lost to tax before it reaches those you’ve left behind.
How? Well the rules state that super will only pass tax free to those who are “financial dependants” of the deceased. And those rules are tightly defined.
Many people have described the rules as a backdoor death tax. That they might be. But every time a new rule is created, strategists come up with ways to get around it, or neutralise it. First, you need to know the problem exists. Then you can plan how you’re going to deal with.
To start, there is some “reasonableness” to the law. The essence behind the law is that:
- If super is being left to a financial dependant, it will be received tax free.
- If it is to be received as, essentially, a free gift, the government wants a claw back a portion of the tax it hadn’t previously charged.
Death of a spouse
A heterosexual spouse is automatically considered a financial dependant. And from two years ago, a gay spouse is considered the same. Leaving the remains of your super fund to your spouse is rarely going to cause an unforeseen tax issue.
Unless your spouse dies first. Or in the same accident, in which case legal precedent might determine who died first (usually the male).
Death of a parent
Children under 18 are automatically considered a financial dependant. Post age 18 is where potential problems begin. After that age, they need to show an “interdependent relationship”, which is a close personal relationship of people who live together where one or both provides financial or domestic support and care for the other.
So, a mooching 24-year-old university student son who is still living off his parents and dependent financially in every way might be able to pass themselves off as a financial dependant. But his twin living at home with the respectable full-time job? Probably not. There’s some definite grey there.
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Away from that, it’s fairly clear that the government doesn’t want money being passed to others without them clawing back a portion of what they didn’t tax, or taxed very lightly, the first time around.
Your super is split down into three parts:
- Tax-free taxed
- Taxable taxed
- Taxable untaxed
In the event of your death – if your intention is to minimise the tax your dependants will have to pay – the best type of money to have in your super fund is “tax-free taxed”. This will largely be made up of non-concessional contributions. Non-concessional contributions have been fully taxed on the outside of super, before being put in, so the government has no further interest in taxing them.
Taxable taxed means the contributions have already been taxed, but there could still be some tax to pay. This is predominantly Superannuation Guarantee and salary sacrifice contributions. If this money is left to a non-dependant, then there is still some tax to pay – about 15%.
Then there is the untaxed schemes, which is only about 10% of the population and is largely the old-style defined benefit funds run, predominantly, by governments.
Again, if the money is left to dependants, there is no tax to pay. However, if the money is left to non-dependants, the government would put it’s hand out for 30% of the first $1.1 million (for the 2009-10 financial year just ended.) Anything over $1.1 million would be taxed at the top marginal rate, PLUS the medicare levy.
Given that, for every $1 million in a super fund being left to a non-dependant, the tax due could be as little as zero or as much as $465,000. There’s a big difference.
We can’t go into all the intricacies of how to reduce that tax today. But there are a few things that everyone should consider when putting thought into how to maximise what’s being left to adult children in particular.
Money outside super doesn’t face the death tax
Firstly, cash sitting outside a super fund at death, is not taxable in the same way. That is, if your health is failing and you still have your wits about you (I’m being serious), you might want to start pulling some money out of super and putting it in your personal name.
Sure, you’ll pay tax on any earnings that the funds generate outside of super, but paying income tax on cash earning 5% in a bank account is certainly cheaper than paying 15, 30 or 46.5% tax on the entire sum.
Increase your tax-free taxed
Put more of your super beyond the taxman. One way to do this is via a recontribution strategy.
When you hit certain conditions of release, you are able to withdraw money from super and, subject to meeting certain contribution conditions, you can recontribute the money to super as non-concessional contributions.
Let’s assume you have a $1 million super fund – all of which was SG and salary sacrifice contributions and earnings on those contributions (taxable taxed). Now you’ve turned 60 and have retired, you can take that entire $1 million tax-free, if you like. However, this would leave you with earnings outside of super which would become fully taxable.
Or you could take out a portion, say $450,000, and recontribute it to super as a non-concessional contribution. Now 45% of your super fund is tax-free taxed. Over time, it can make sense to increase the amount that you have in the fund on which all tax is paid, as it will pass to your adult children in that way.
Bruce Brammall is director of Castellan Financial Consulting and author of Debt Man Walking.