UNLIKE many countries in the developed world, Australia doesn’t levy an inheritance tax.
In fact, any politician knows that if they were to suggest that Australia adopt an inheritance tax, they would be out of a job pretty soon.
So, no politician will ever suggest it.
However, quite often when a person dies in Australia, their inheritors have to pay tax on what they inherit.
It’s not called an inheritance tax, but it might as well be.
The rate is 17 per cent. Could be worse, but it’s still a big slice.
This is how it works.
How the inheritance tax comes about
It’s all to do with superannuation, which increasingly is where people’s life savings are kept.
When a person dies, any money left in superannuation becomes part of the person’s estate.
In superannuation, there are two types of contributions which a person can make. One is a before-tax contribution and the other is an after-tax contribution.
Before-tax contributions are the compulsory contributions your employer has paid on your behalf while you were working plus perhaps some pay you salary-sacrificed into super.
These before-tax contributions are invested by your super fund and make you more money. While you’re working, you pay 15 per cent income tax over both the before-tax contributions and the return on those contributions. That’s generally a much lower rate than you would have paid outside super. Once these contributions are transferred to your superannuation pension account, no tax is payable on money you withdraw.
Examples of after-tax contributions are lottery winnings, an inheritance lump sum, gifts and so forth, when you put them into your super. These are all sums over which tax has been paid or which were tax-free to begin with. So, once these contributions are in your super fund, no more tax is payable on them.
The rule is that, if you leave superannuation as part of your estate, the beneficiary pays 17 per cent income tax over the before-tax part of the inherited sum. That’s the money your employer has contributed and any money you have salary-sacrificed into super.
Again, it’s not an inheritance tax but it is a tax which is triggered by someone’s death.
How to avoid inheritance tax
What follows here is not financial advice but a general discussion about how superannuation works once it becomes part of a person’s estate.
It gets a bit technical but stay with it. Your inheritors will thank you for it.
The solution for the inheritance tax essentially is to turn your before-tax contributions into after-tax contributions.
After-tax contributions are tax-free for ever and for everyone, including your inheritors.
How do you do that?
The first step is to be 60 or over and retired and to place all your before-tax contributions into your superannuation pension account, if they’re not already there.
The second step is to withdraw these funds from your superannuation pension account by transferring the money to a bank account (outside super). This withdrawal is tax-free.
The third step is transferring the money back into your superannuation fund. It will be received in your accumulation account and can then be moved into your pension account if necessary.
Congratulations, your before-tax contributions have now become after-tax contributions. Once you pass, your inheritors will not have to pay any tax over that money.
Sounds like money laundering?
Maybe, but it is legal. It typically protects what are going to be relatively small inheritances. Because you’re still very much alive and kicking when you do this, and you are likely to be spending quite a bit of money before you shuffle off your mortal coil.
The limits of super ‘laundering’
One limit is age.
After 75, no contributions can be made to superannuation. So, you can withdraw before tax contributions all you like when you’re 75, you won’t be able to get them back in.
Then there are the after-tax contribution limits.
The current after-tax contribution limit is $110,000 a year. However, you can make three years’ worth of contributions in a single year, or $330,000.
That’s per fund member. So, a couple could contribute $660,000 in a single hit.
After that, you will have to wait for three years before it can be done again.
Also, superannuation operates with what’s known as a transfer balance cap.
This refers to the maximum dollar amount a person can transfer from their accumulation account in their super to their pension account.
This lifetime cap currently stands at $1.9 million.
The way it operates is that any money you transfer uses up some of the cap. For example, if you pulled $330,000 out of your pension account and put it back in, you will have used up $660,000 of your transfer balance cap. So, there’s a limit to the number of times you can do this.
Get financial advice
Again, this CPSA News post merely tries to outline how, in general, you can protect your estate from a de facto inheritance tax. Should you think about it? That’s up to you.
If you think this could be useful to you, make sure you get proper, specific financial advice before doing anything.
Your inheritors will thank you for that as well.
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