Peter Oliver and Bernard Finnegan look at the tax treatment of death benefits under recent superannuation reforms.
Major superannuation tax reforms, such as those from the May 2016 budget, create risks that potentially unintended consequences may arise, some of which are not immediately obvious. An example which has arisen recently relates to the rules introduced to allow death benefit dependants to roll over lump sum superannuation benefits into income streams. The issue arises when the benefits are funded from insurance death benefit payouts.
Various policy issues seem to intersect here. Firstly, because monies held in the superannuation system are concessionally taxed, there are rules to restrict the amount that may be held in the system and how monies may enter and leave the system. Secondly, due to the financially dependent nature of the certain beneficiaries of deceased superannuation members, more concessional tax rules apply so as to mitigate further hardship. Thirdly, premiums for life insurance which will fund superannuation death benefits are tax deductible to superannuation funds, effectively offsetting the tax on assessable contributions, so there is a claw-back rule which may apply.
If a death benefit dependant takes a lump sum payment of the superannuation death benefit, the lump sum is not assessable to that person. But under the reforms, since 1 July 2017, the death benefit dependant may choose to roll-over the benefit to another superannuation fund to be taken as an income stream. This is intended to allow more flexibility to the dependant. However, because the benefit from the deceased member’s fund is technically a superannuation lump sum, where that payment derives from the insurance death benefit, a claw-back rule operates. The effect is to apportion the benefit into components, including an “element untaxed in the fund”.
The benefit rolled-over is deemed to be a contribution to the receiving fund and contributions tax will apply to the “element untaxed in the fund” in the new fund. Hence, the death benefit dependant effectively incurs a 15 percent tax on that component, whereas if a lump sum payout was taken this should not arise. This would seem to be an unintended outcome. The deductible insurance premium claw-back rule, as presently drafted, does not distinguish between benefits to death benefit dependants (as defined) and non-dependants, depriving the former of concessional tax treatment.
This issue has emerged as unaware beneficiaries are accessing the new roll-over choice. It has been raised with the Australian Taxation Office (ATO) and we understand Treasury has also been alerted. Industry submissions are also being prepared.