When you’ve worked hard and saved diligently for retirement, it’s natural to want any money left in your superannuation account to benefit your loved ones, not be eaten up by tax. But what many people don’t realise is that superannuation isn’t automatically tax-free when passed on to beneficiaries, especially if those beneficiaries are your adult children or other non-dependants.
As financial advisers, this is something we’re often asked about — and rightly so. Let’s take a closer look at how tax applies to inherited super, and more importantly, how you might be able to minimise the tax your beneficiaries will pay.
First, a quick recap: what happens to your super when you die?
When you pass away, your super balance (including any life insurance held within super) is usually paid out as a super death benefit. This benefit goes to your nominated beneficiary, or your estate if no beneficiary has been nominated.
Now, here’s where it gets important: how that death benefit is taxed depends on who receives it and how it’s paid.
Who is considered a dependant for tax purposes?
The ATO defines dependants for tax purposes a little differently than you might expect. People who fall into this category include:
- Your spouse or de facto partner
- Children under 18
- Anyone financially dependent on you
- Someone you had an interdependency relationship with
If your super is paid to someone in this group, they’ll generally receive it tax-free, whether as a lump sum or income stream.
But if your super is left to adult children or other non-dependants — which is very common — things change.
What tax do adult children pay on inherited super?
Adult children are classified as non-dependants for tax purposes (unless they were financially dependent on you, which is rare).
If they receive your super as a lump sum, they may have to pay tax on the taxable component of your super at up to 15% (plus Medicare levy).
The taxable component is made up of contributions that came from your pre-tax income — such as employer SG contributions and salary sacrifice — and earnings on your investments. For most people, the bulk of their super balance sits in this bucket.
There’s also a tax-free component, usually made up of non-concessional (after-tax) contributions. This part is, as the name suggests, tax-free to all beneficiaries.
So when a non-dependant inherits your super, the key question becomes: how much of your super is taxable vs tax-free?
A simple example: John’s situation
Let’s say John is a retired 75-year-old with $800,000 in super.
- $640,000 of this is in the taxable component
- $160,000 is in the tax-free component
John nominates his two adult children as beneficiaries. If he passes away and his super is paid to them directly:
- They each receive $400,000
- Of that, $320,000 is taxable, and $80,000 is tax-free
- On the $320,000 taxable component, they’ll each pay up to 17% tax (15% + 2% Medicare levy)
- That’s $54,400 in tax each — or $108,800 total
That’s a significant amount lost to tax, especially when you consider that, with some planning, this outcome might have been improved.
So what can you do to reduce this tax?
While you can’t completely eliminate the tax in every case, here are three practical strategies that may help reduce it:
1. Withdraw taxable super and recontribute it as a non-concessional contribution
This is commonly referred to as a recontribution strategy.
It involves withdrawing a portion of your super (which will be mostly taxable), then tipping it back into your fund as a non-concessional (after-tax) contribution, assuming you meet the eligibility rules.
Doing this gradually over a few years can shift more of your super balance into the tax-free component, which your children can inherit without tax.
NOTE: This strategy is best done with advice, as it has limits and eligibility requirements — including age limits and contribution caps.
2. Draw down more from super while you’re alive
If you don’t need to preserve your entire super balance, you may choose to draw down more of it during your lifetime. This means using the money yourself or gifting it to your children while you’re alive.
While this doesn’t reduce tax on a death benefit directly, it can reduce the amount left in super — and therefore the amount taxed on death.
3. Consider your estate planning structure
Some people direct their super to their estate rather than to individuals, using a non-binding nomination or a reversionary pension. This can allow more flexibility in distributing funds — especially if there are dependants and non-dependants in the picture.
That said, estate planning can be complex, and this approach doesn’t remove the tax — it just opens the door to strategic distribution via a will or testamentary trust. Again, best done with professional advice.
Don’t wait until it’s too late
Most people only start thinking about this stuff after they retire — or worse, when their health takes a turn. But the truth is, a little proactive planning in your 60s or 70s can save your family tens of thousands of dollars later on.
At HPH Solutions, we help our clients not only grow their wealth but also transfer it in the most tax-effective way possible. Every family situation is unique, which is why tailored advice is essential.