Australia’s most unpopular taxes – death duties – were formally abolished at the federal level in 1979 and by all states by 1982. That said, as we like to say, they still exist by ‘stealth’ and are embedded into our superannuation system and are paid on death.
This is called ‘Death Benefits Tax’ within superannuation and can be as high as 30% (plus medicare levy), in some circumstances, however, for most superannuants the tax is 15%. On the surface, this may not sound excessive, however It is worth noting, the tax is payable on the ‘superannuation balance’ and not the income so can quickly escalate to a large number.
Death benefit tax is calculated after all internal superannuation have been paid, included the new Division 296 tax. For most people, who live to life expectancy, the tax is typically 15% and applies only to the ‘taxable portion’ of their superannuation benefit. However, because the tax is applied to the capital, rather than income, the actual tax payable can feel high and can come as a complete surprise to many. Hence, we refer to this tax as a ‘death tax’ by stealth.
In our professional experience, this can add a layer of complexity which many people overlook when completing their estate plans. That said, like many things, a clear, concise estate plan can make a significant difference.
To explain:
Super does not form part of your will
Again, a point many people don’t understand, superannuation does not form part of your will, unless you make a specific nomination for this to occur.
You can direct your super to be paid directly to your, spouse, children or other dependants through a binding death benefit nomination. This can be beneficial when there is a risk of a will being challenged or there are complexities within the lives of your beneficiaries.
This really highlights the importance of understanding where your superannuation will be paid and what taxes will be withheld so that what you think will happen in your estate plan, actually happens. For many, this can lead to surprises and difficulties for estate to administer.
Why the transfer balance cap matters
The transfer balance cap is central to understanding how super operates in retirement. For someone retiring today, the general cap is $2 million. Amounts held in pension phase up to this cap generate tax‑free income.
Your personal transfer balance cap is set when you first commence a retirement‑phase pension. If you fully utilise your cap, you are not entitled to future indexation increases. If you only use part of it, you retain a proportional entitlement to future increases.
These rules become especially important on the death of a spouse. Where a reversionary pension is in place, the surviving partner has up to 12 months to deal with any amount that exceeds their personal transfer balance cap. Any excess must be moved back to accumulation phase, where earnings are taxed at 15 per cent.
Reversionary pensions are often an effective estate planning tool for couples. They provide a period of flexibility and allow super to pass to a spouse tax‑free. By contrast, where there is no binding nomination or reversionary pension, the trustee of the fund ultimately decides who receives the benefit, which can result in delays and uncertainty.
Non‑spouse beneficiaries will generally receive super as a lump sum. While dependent children may receive a pension, that income stream must usually be converted to a lump sum by age 25 unless the child has a permanent disability. Income received by child beneficiaries can also be subject to tax.
Strategies to reduce death benefits tax
In theory, the simplest way to avoid the 15 per cent death benefits tax is to withdraw all super before death. In practice, this is rarely workable. Doing so requires knowing when you will die, and withdrawing too early can mean losing the long‑term benefits of the superannuation system, including tax‑free pension income and concessional tax rates on earnings.
That said, in limited circumstances – such as following a terminal diagnosis after age 65 – withdrawing super before death can be a legitimate strategy. Amounts withdrawn within the $2 million transfer balance cap are tax‑free.
Another commonly used strategy is the recontribution strategy. Once a condition of release has been met (generally retirement after age 60 or turning 65), funds can be withdrawn and recontributed as a non‑concessional contribution. This effectively converts taxable super into tax‑free super for death benefit purposes.
However, there are strict limits. Recontributions are capped at $120,000 per year (or $360,000 under the bring‑forward rules), cannot be made after age 75, and are not permitted if your total super balance exceeds $2 million.
This becomes particularly relevant for couples. Two members each holding $1.2 million are within the limits, but if one partner dies, the survivor may suddenly exceed the $2 million threshold and lose the ability to recontribute.
There are also specific considerations for beneficiaries who live overseas. In some cases, super paid to a non‑resident child may not attract the Medicare levy, and double taxation agreements may further reduce or eliminate Australian tax.
The added complexity of Division 296
Looking ahead, the new Division 296 tax adds another layer of complexity, particularly for self‑managed super funds. From 1 July 2027, members with super balances exceeding $3 million will face an additional 15 per cent tax on earnings attributable to the excess. Balances above $10 million will face an additional 10 per cent.
For single‑member SMSFs, this will complicate the process of winding up the fund after death and reinforces the broader point: tax is only one piece of the estate planning puzzle.
Conclusion
In conclusion, superannuation decision should always be made in the context of family dynamics, control, certainty and long-term outcomes, not tax alone. A carefully constructed estate plan which has a strategy for potential superannuation taxes and includes with a well drafted will and an appropriate valid binding death benefit nomination can provide certainty over your desired outcome.