Noel Whittaker writes exclusive weekly blog updates for the Ban Tacs Group, with IN8 Business Advisory, a member of that group. Here, he talks about the tax implications of insurances held inside and outside of super.
It is a common strategy to arrange your life insurance through your super fund. The fund can often buy insurance at wholesale rates, and by using salary sacrifice, you can effectively pay the premiums from pre-tax dollars.
But tax may be payable on the proceeds of the policy if it is left to a non-tax dependant. Often a young single person has, say, $300,000 of death cover through their work super fund. They are unlikely to have tax dependants, so if they were killed in a car accident the Tax Office would take around $100,000, leaving around $200,000 in their estate.
Where tax is payable by an estate the tax becomes a general liability of the estate.
Think about a single father aged 50 with three adult children who all work – one of them lives at home with him. His house was worth $380,000 in 2008 when his will was drafted. He has $300,000 in super fund A, and just $15,000 in super fund B. There is also a $300,000 insurance policy in super fund B – this is this fund that is paying the premiums because it has the smallest balance.
He wanted his will to treat his children equally. Therefore, it was drafted to give the first child the proceeds of Fund A, the second child the proceeds of Fund B and the residue of his estate to child three who was living at home. The father figured that would be the house and the contents.
Unfortunately the will drafter didn’t understand the effect of the death tax on insurance policies held in superannuation.
When the father died suddenly the children got a terrible shock when they discovered they were not going to be treated equally at all. Ordinarily it would be thought that the first child would receive around $255,000 as the proceeds from Fund A would be taxed at 15%, while the proceeds of the insurance policy held by Fund B would yield approximately $215,000 after the tax of approximately $100,000 was deducted. Life insurance proceeds held within superannuation suffer a much higher tax than ordinary superannuation benefits because they are treated as “untaxed” and are subject to 30% tax (excluding Medicare levy) when paid to a non-dependant.
Problem 1! Super funds do not deduct the death tax and send the balance to the estate. Rather, they send the entire amount to the estate – it is the estate which has the obligation to send the death tax to the ATO!
Problem 2! Because the will specifically gave “the proceeds of Fund A” to the first child and “the proceeds of Fund B” to the second child they would be entitled to the whole of $300,000 and $315,000 respectively. The tax still has to be paid – it just won’t be coming out of the proceeds received from either of Fund A or Fund B. The executor of the estate has a responsibility of paying $145,000 to the Tax Office ($45,000 death tax on Fund A and approximately $100,000 death tax on Fund B).
Because children one and two have received specific bequests, the tax can only be paid out of the residue of the estate. Using a concept known as “marshalling” the executor will probably have to sell the home to pay the $145,000 tax bill leaving child three with net benefits of only $105,000. Not only has the third child borne the cost of the tax payable on both of the superannuation payouts- the family home has been lost to pay the tax bill.
Noel Whittaker is the author of Retirement Made Simple and numerous other books on personal finance. Email: noel@noelwhittaker.com.au
28 Feb 2021
