One of the changes proposed in the Government’s 2012-13 Mid Year Economic and Fiscal Outlook, delivered by Treasurer Wayne Swan earlier this week, provides some certainty for taxpayers regarding the taxation treatment of superannuation death benefits.

Here, special counsel Justin Byrne and solicitor Hannah Byrne explain how the proposed change will affect the payment of superannuation death benefits.

Key points

  • The Government is proposing to amend the current law to allow the tax exemption on superannuation pension investment earnings to continue following the death of a fund member until the member’s benefits have been paid out.
  • This amendment will remove previous uncertainty as to whether the tax exemption on superannuation pension investment earnings ceases as soon as a fund member dies.
  • The change is intended to have retrospective effect from 1 July 2012.

How are investment earnings from pension assets usually taxed?

Ordinary and statutory income that a complying superannuation fund (including a self managed superannuation fund) earns from assets held to provide for superannuation pensions is exempt from tax.

Whether this exemption ceases as soon as the member dies has been an area of uncertainty for superannuation funds. If the exemption ceases, then there is a possibility of double taxation where a death benefit has to be paid out of a superannuation fund. In other words, if any investment assets have to be sold to pay out the death benefit, then capital gains tax of 10 percent will apply, plus another possible 16.5 percent tax if the benefit is paid to certain beneficiaries (such as adult children).

The Government’s announcement in the Mid Year Economic and Fiscal Outlook confirms that the law will be amended to allow the tax exemption for pension earnings to continue following the death of a pension recipient, until the deceased member’s benefits have been paid out of the fund.

This will mean that superannuation fund trustees can dispose of pension assets on a tax-free basis to fund the payment of death benefits, eliminating the obligation on super funds to pay CGT where super pension assets have to be sold to pay out a benefit. As a result, tax will then only be payable if the benefit is paid to a non-dependant, such as an adult child.

Superannuation law requires a deceased member’s benefits be paid out of a superannuation fund as soon as practicable following the member’s death. The proposed continuation of the pension earnings’ tax exemption after the death of a fund member will be subject to this requirement.

Why this is good news for those who operate SMSFs

This change will benefit beneficiaries of deceased estates by allowing the superannuation fund trustees to dispose of pension assets on a tax-free basis to fund the payment of death benefits. This could result in some significant tax savings, particularly where a superannuation fund has held real estate within the fund for a considerable amount of time.

This proposed change may also encourage superannuation fund trustees to further invest in real estate and/or other assets. Previously, superannuation fund trustees may have been reluctant to invest in real estate due to the potential for significant capital gains tax liability, particularly where the superannuation fund has held the real estate for an extended period of time.