As you may be aware, last month we spoke about this topic on the show and we received the most enquiries of any show to date! It was obvious based on this that it is a huge concern for retirees and we thought a follow up on this issue would be prudent.
So what’s this all about?
The “death tax” is the tax on your super or pension that is left to an adult non-dependent child upon your untimely passing.
Let’s consider Account Based Pension accounts first as this is where you have some control over the outcome.
In a relationship the usual or simplest thing could be to simply have a reversionary pension to each other, what this means is that if something happens to one of you in a couple then the pension simply reverts to the other person and is continued to be paid. We have no tax issues here.
Where is the issue for pension accounts? It’s when we have made an election to leave some of these proceeds to one of our adult kids and unfortunately, the devil is in the detail.
In simple terms, at the time when you contributed money to super and you did not claim a tax deduction, then when these proceeds come out there will be no tax issues on the exit (this is simple enough).
However, if you did claim a tax deduction for some of these amounts when they went in as a contribution or it was an employer super guarantee contribution, then these contributions incurred a 15% contribution tax upon entry. That saved you tax at the time rather than paying your marginal tax rate, but and here is the big BUT, when these proceeds are directed to an adult non-dependent child upon death (and that could mean a “child at any age over 18 ie. 60 years old), these proceeds are then taxed.
What does this look like?
When a superannuation death benefit is paid to a non-dependent adult child in Australia, the tax treatment depends on the components of the superannuation balance. The taxation is as follows:
1. Taxable Component (Taxed Element)
- Taxed at 15% plus Medicare Levy (2%), making it 17% total.
2. Taxable Component (Untaxed Element) (only a small amount of people)
- Taxed at 30% plus Medicare Levy (2%), making it 32% total.
3. Tax-Free Component
- No tax is payable
Here is an Australian Taxation Office (ATO) example for factual reference: https://www.ato.gov.au/tax-and-super-professionals/for-superannuation-professionals/apra-regulated-funds/paying-benefits/paying-superannuation-death-benefits
Example: taxed and tax-free proportions on super income stream
Anna dies on 1 December 2015 at 66 years old. When she dies, Anna is receiving an account-based super income stream.
The tax-free and taxable components of her income stream are worked out as follows:
- tax-free proportion of 25%
- taxable proportion of 75%.
Anna’s account balance when she dies is $200,000. This amount is paid to her beneficiary, her spouse Brian, as a lump sum on 11 March 2016. As the lump sum is paid from the same super interest as Anna’s income stream, the proportions of the tax-free and taxable components are exactly as they were for her income stream.
The tax-free and taxable components of Brian’s lump sum death benefit are:
| Tax-free component | = $200,000 × 25% |
| = $50,000 | |
| Taxable component | = $200,000 − $50,000 |
| = $150,000 |
As Brian was Anna’s dependant, the total benefit is tax-free.
If Brian was a non-dependant, the taxable component is assessable.
Untaxed element (This will not be relevant to most people)
The untaxed element includes amounts where a fund has not paid any tax on the contributions or earnings. Higher rates of tax will apply to benefits containing an untaxed element.
Untaxed super funds are generally run by Commonwealth, State or Territory government departments, and are generally either:
- public sector super schemes
- constitutionally protected funds.
The Taxed element is the Key to dealing with this issue
- The taxed element includes amounts where a fund has paid 15% tax on the contributions or earnings. Concessional rates of tax will apply to benefits containing a taxed element. A taxed element may also include an amount that has been rolled over from an untaxed source.
This is where you have options. We recommend that you consult with your financial adviser, as they can provide significant value to you, your family, and your legacy. They can discuss strategies such as cash and re-contribution plans for your superannuation.
I cannot delve into specific advice on the radio, as it will vary based on your individual circumstances. Therefore, it is essential to speak with your adviser or your superannuation provider (if it is an industry-based fund), to gain a better understanding of this matter.
Alternatively, you can reach out to one of our team members at RFS Advice and we can provide specific advice based on your own individual circumstances.
Honouring your Legacy
Someone is sitting in the shade today because someone planted a tree a long time ago. (Warren Buffet)
Have you ever wondered how it is that you have worked hard your whole life and been well paid but there seems to be a group of individuals and families that are miles in front of you?
Do they have a secret?
Not everyone starts from the same spot. There are some families that are starting well down the track, before the gun has even gone off.
They get to build on the wealth of previous generations and establish a legacy for the next.
Can that be you and your family?
It requires patience and planning, but it is a possibility for any family to start that has accumulated assets throughout their lifetime. The key is compounding and keeping the asset base together.
A good example is long running family businesses or farming families. They have built on the foundation over time and compounded to consolidate their positions.
This is not always easy though because what generally happens is that estates are wound up and everyone goes their separate ways.
The power of compounding
We need to keep the capital together and let it grow.
If you invested $1million and let it grow at 7.2% for 10 years it could double to around $2million dollars. If you let it grow another ten years after that it could accumulate to over $4million.
7.2% net growth is a reasonable target to aspire to. Yes, you have inflation eroding some purchasing power, but it would still be a very useful target.
Let us break this down into net Asset Position for strategies
Group 1 – Homeowner with additional net assets under $500,000:
- The income for this group is generated from the Government age pension and a possible part self-funded pension.
- The net assets in this instance will be the home plus any super/savings they have accrued.
- This group could still have a net asset position well in excess of $1 million as house prices have increased so much in recent times.
Group 2 – Homeowner with additional net assets of around $1 million:
- The income for this group would be generated from a self-funded pension, commercial properties or a business or possible draw down from other assets.
- Their portfolio would probably consist of some income producing assets as well as capital assets.
- There will be net assets of several million dollars.
- Some different family members may wish to honour a legacy and maintain ownership of some of the assets.
Group 3 – Homeowner with additional net assets well over several million dollars:
- The income for this group will be a self-funded pension and a possible draw down from other assets.
- They would not be entitled to the Government age pension payment.
- Their portfolio would probably consist of some income producing assets as well as capital assets.
- There will be net assets of several million dollars and there could be significant benefits in maintaining the assets and continuing to generate an ongoing income stream.
- Some different family members may wish to honour a legacy and maintain ownership of some of the assets.
Planning for the groups:
Group 1 Homeowner with additional net assets under $500,000
Within this group we would be looking to ensure that you are receiving your maximum Centrelink entitlements and making sure you use these benefits at every opportunity. A large number of people in this group now actually have assets worth well over $1 million dollars and this is usually the home. Fortunately, under the age pension eligibility tests, the home is not included when assessing entitlements for the age pension.
There is often a hard choice though in this category as people can find that they have some assets but feel income poor. They may want to access the equity in their home to have additional funds for their retirement. It can be a difficult decision when it comes to maintaining their home versus selling the home and downsizing to access some of that equity but then potentially losing all or part of the age pension as their asset base is now higher under the pension eligibility tests.
For people in this group there is a key focus for them on generating retirement income. They need this managed to maximise a full or part age pension and top up their lifestyle out of their savings. You may be entitled to some homecare packages.
The legacy in this instance is probably the family home and they will tend to focus on maintaining this asset if it is worth a significant value versus a part age pension.
Group 2 Homeowner with additional net assets of around $1 million:
At RFS advice we help lots of people that have assets in and around the $1 million mark and also those well above this every day. They have a focus on generating an ongoing income, maintaining the legacy and growing wealth for future generations.
We can help them focus on generating their ongoing income need to provide for this desired lifestyle. We then set a goal on maintaining and building the capital base along the way.
Some of these clients will help the kids and grandkids along the way. Others will wish to maintain control of the capital base.
Some of these clients could have a family business that the kids work in. We help the family group work on a transition of the business over to the next generation. For a lot of clients, they simply intended to sell the business and retire. That is the business that provides for their kids and grandkids. An alternate view is to pass control over and potentially draw an income over time from the business.
The key to retirement is income. By keeping the business in the family it will maintain your income in retirement. It provides for future generations. It allows the next generation to kick-start their career by leveraging off all of your hard work.
A traditional approach is to sell the business, then you need to support the kids and grandkids while they start again.
Each family and business is different but the concept is what is important.
Group 3 Homeowner with additional net assets well over several million dollars
We also work with families in group 3 to help manage all of their assets, others we manage some of the assets. We are finding that a lot of family groups want to know we are here if their health changes and they want someone to take over the decision making and management.
Traditionally these higher net worth families have managed a lot of their assets themselves. They are moving from a case of creating wealth to protecting wealth. That is a different skillset.
We call this off farm assets. So in farming terms let’s have some assets outside the farm or for business clients let’s have some assets outside the business.
These groups will have assets that it makes sense to compound together and continue to build off as they have large assets that no single family member could afford on their own. Then separate to this each family group will have their own asset positions.
Each of the different family groups will have a different problem that needs a different approach. There is no single solution and these can change along the way and most have the same desires:
Grandparents, heads of the family: They could be in retirement living or Aged Care and they want quality of life.
Parents or retirees: They want their desired income to fund their desired lifestyle.
Adult kids: They have kids at school and mortgages and are time poor. They need help.
Grandkids: They will benefit or not depending on the actions of everyone above.
The key concept is to have the correct team to work with you along the way to identify and deliver your desired outcome.
When planning for your future retirement and family legacy, following are some concepts that should be considered:
- Do you spend the capital or invest the capital and live off the income?
- Help the kids now along the way or inherit more later?
- Do you work together as a family on some assets and not others?
- Do you all go your separate ways?
- Do you want to create a legacy?
And finally, I want to leave you with this thought:
It is about how the little things we do today can have an impact in the future, even if we don’t see them right away. Like planting a tree, you don’t get to enjoy its shade right away, but someday someone will, and they’ll be grateful for it.
Our team would love to help you and your family.
General Advice Warning: The information provided in this document does not constitute financial product advice. The information is of a general nature only and does not take into account your individual objectives, financial situation, or needs. It should not be used, relied upon, or treated as a substitute for specific professional advice. We recommend that you obtain your own independent professional advice before making any decision in relation to your particular requirements or circumstances. RFS Advice does not warrant the accuracy, completeness, or currency of the information provided in this document.out taking into account your objectives, financial situation or needs. Because of that, you should, before acting on the advice, consider the appropriateness of the advice, having regard to those things.
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