Will your adult children be taxed on your Superannuation when it’s passed on?

There’s a common and costly misconception that when your superannuation is passed on to your children, it’s entirely tax-free. Unfortunately, that’s not true if your children are adults and considered non-dependents for tax purposes.Understanding how death benefit tax works and how to reduce it is a crucial part of estate and retirement planning.

Who pays tax on Superannuation Death Benefits? 

Superannuation is not automatically included in your estate. It’s paid directly by the super fund to your nominated beneficiaries or to your estate if no valid nomination exists.

Whether or not tax is payable depends on who receives the death benefit.
If your beneficiary is a dependent under tax law, such as a spouse or a child under 18, the superannuation death benefit is generally tax-free.

However, if your beneficiary is an adult child who is financially independent, they are considered a non-tax dependent. In that case, they may be required to pay tax on the taxable component of your superannuation. This tax is typically 15%, plus an additional 2% Medicare levy resulting in a total tax rate of up to 17%.

This often comes as a shock to families who assume all super benefits are tax-free.

What is the Taxable Component of Super?

Your superannuation balance is made up of two parts:

• The tax-free component – usually from non-concessional (after-tax) contributions you’ve made.
• The taxable component – typically made up of employer contributions, salary-sacrificed amounts, and earnings on your super.

Only the taxable component is subject to tax when paid to a non-dependent. Unfortunately, for most people, a significant portion of their super is in the taxable component.

Without planning, this can result in a sizeable portion of your super being lost to tax instead of being passed on to your children.

How to reduce the Tax for adult children

The good news is that with the right planning, it's possible to reduce or in some cases, eliminate the death benefit tax.

One of the most effective strategies is called the withdrawal and re-contribution strategy.

Here’s how it works:

1. Once you have met a condition of release (such as retirement) and are aged over 60, you can withdraw part of your super tax-free.
2. You then re-contribute those funds back into your super as a non-concessional (after-tax) contribution.
3. This process shifts money from the taxable component to the tax-free component, reducing the amount of super that would be taxed when paid to a non-dependent.

This strategy can be done over multiple years, subject to contribution caps. As of the current financial year, you can contribute up to $120,000 per year, or $360,000 under the bring-forward rule if eligible.

It’s important to note that this strategy isn’t suitable for everyone, and should always be carried out under professional advice. Eligibility, timing, contribution caps, and Centrelink implications all need to be considered.

Why early planning matters

Many Australians don’t think about how their super will be taxed when passed on especially if they assume it simply goes into their will or estate. But super operates under different rules and ignoring them could leave your loved ones with an unexpected tax bill.

Planning ahead gives you more options. If you're still working, there may be time to restructure your contributions. If you’ve already retired, you may be able to withdraw and re-contribute funds over several years to reduce the taxable component.

Even small changes made in your 60s could result in significant tax savings for your family later on.

Why you need a professional adviser

At PKF, we regularly work with clients who want to maximise the legacy they leave behind not just in terms of value, but in terms of tax efficiency.

Our advisers can help you: 

• Understand the tax implications of superannuation death benefits
• Model different scenarios based on your super balance and family situation Implement withdrawal and re-contribution strategies where appropriate
• Align your superannuation nominations with your estate planning goals

Every situation is different, and the best strategy for you will depend on your personal circumstances, however the earlier you start planning, the more options you have.

If you’re unsure how your superannuation will be taxed or want to protect your family from unnecessary tax, speak with your PKF adviser today.