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Insurance death benefits have tax traps

insurance death benefit SMSF

The tax treatment of a lump sum death benefit from an insurance policy held by an SMSF will vary and cannot be applied to all beneficiaries.

Advisers need to be aware the tax treatment of a lump sum superannuation death benefit from a life insurance policy held within an SMSF will vary for beneficiaries based on whether they are considered a dependant, according to an SMSF technical expert.

Smarter SMSF chief executive Aaron Dunn said there were tax-free and taxable components in a lump sum superannuation death benefit and the treatment of the tax-free component was identical for all beneficiaries, but the taxable component had more details that should be considered.

“The tax-free component is non-assessable, non-exempt income and it’s only when we get to the taxable component that we need to drill down further and understand the tax consequences subject to whether it’s being paid to a dependant or a non-dependant,” Dunn said during a recent webinar.

“Now for a tax dependant spouse that taxable component is also paid as tax-free as it is to any other tax dependant, such as a child, someone who is interdependent or in a financial dependant arrangement.”

He said this would differ from a non-dependant, such as an adult child who could be a Superannuation Industry (Supervision) dependant, but they are a non-tax dependant, and questions needed to be asked about whether the benefit is being paid directly to them or to an estate.

“If we had a binding death benefit nomination or the trustees deemed to pay it to adult children and it was paid to them directly, then there would be an obligation to not only withhold the 15 per cent amount on the taxed element, or the 30 per cent on the untaxed element, [but] there would be an imposition of the Medicare levy that would have to be deducted as well,” he said.

“If it is paid to the estate, so the legal personal representative will come into the fund, pick up the money and move it across to the estate, then there is no imposition in that regard of any Medicare levy at that point in time.

“It is worth noticing the nuances there around the different elements because if we’ve got insurance proceeds coming into the SMSF, we are going to see an untaxed element come into play here and then we’ll have a taxing consequence, particularly for any non-dependants.”

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