For most Victorians, your superannuation is your biggest asset after the family home. You’ve worked hard, and dutifully contributed a portion of your income, watching your nest egg grow. But there’s a hidden tax trap that many Australians are completely unaware of—one that could see your adult children lose a significant chunk of their inheritance before they even receive it.
While Australia officially abolished inheritance taxes decades ago, a de facto death duty exists within the superannuation system. When your super passes to a non-dependant beneficiary, such as an adult, financially independent child, the taxable portion of that balance is hit with a 17% tax. That’s a 15% tax plus the 2% Medicare levy.
As compulsory super contributions have grown from just 3% in 1992 to 12% today, the taxable component of most super funds has ballooned. This means a larger portion of your life’s savings is exposed to this tax. For many Victorian families, this can amount to tens or even hundreds of thousands of dollars lost. The good news? With careful planning, you can legally minimise or even eliminate this tax.
Why is Inherited Super Taxed? Understanding the System
The tax treatment of a super death benefit hinges on two key factors: the composition of the super balance and the relationship of the beneficiary to the deceased.
Taxable vs. Non-Taxable Components
Every super account is made up of two parts:
- Taxable Component: This is the largest part for most people. It includes all contributions that received a tax concession, like compulsory employer contributions (the Superannuation Guarantee), salary sacrifice amounts, and any personal contributions you’ve claimed as a tax deduction. All the investment earnings on these amounts also form part of the taxable component. The government taxes this portion upon inheritance to “claw back” the initial tax break it gave you.
- Non-Taxable Component: This consists of after-tax money you’ve added to your super, known as non-concessional contributions. Because you’ve already paid income tax on this money, it passes to your beneficiaries tax-free, regardless of who they are.
Who is a “Dependant”?
The second crucial factor is whether your beneficiary is considered a “dependant” under tax law.
- Tax Dependants (Pay NO Tax): These beneficiaries receive the entire super payout, both taxable and non-taxable components, completely tax-free. They include:
- Your spouse or de facto partner.
- Your children under 18 years of age.
- Any person who was financially dependent on you at the time of your death.
- Non-Tax Dependants (Pay 17% Tax): This category includes those who are likely to be the main inheritors of your wealth: your adult children who are no longer financially reliant on you. They will pay 17% tax on the taxable portion of the super death benefit.
Strategies to Protect Your Legacy
The key to minimising this tax is to legally convert the taxable component of your super into the non-taxable component. Fortunately, the system provides several powerful, albeit complex, ways to do this.
The Recontribution Strategy: A Legal Tax Wash
One of the most effective tools is the recontribution strategy. It might sound absurd, but it involves taking money out of your super and simply putting it back in.
Here’s how it works for someone aged between 60 and 75:
- Withdraw: You take a lump sum from your super. If you’re over 60, this withdrawal is entirely tax-free.
- Recontribute: You then immediately contribute the same money back into your super fund as a non-concessional (after-tax) contribution.
- Convert: This simple act “washes” the money. The recontributed amount is now classified as part of the non-taxable component of your fund.
By repeating this process over several years, you can systematically shrink the taxable portion of your super, significantly reducing the tax bill your children will eventually face.
This strategy is limited by the non-concessional contribution cap, which is currently $120,000 per year. However, if you’re under 75, you may be able to use the “bring-forward” rule to contribute up to $360,000 in a single year, accelerating the process.
Binding Death Benefit Nominations (BDBNs)
A common mistake is assuming your will dictates where your super goes. It doesn’t. Super is held in a trust, and its distribution is determined by the fund’s trustee. A Binding Death Benefit Nomination (BDBN) is a legal directive that overrides the trustee’s discretion and forces them to pay your super to the beneficiaries you have specified.
For a BDBN to be valid in Victoria, it must be meticulously prepared:
- It must be in writing, signed, and dated by you.
- It needs to be witnessed by two adults who are not named as beneficiaries.
- Crucially, both witnesses must sign in your presence.
A powerful strategy is to nominate your “Legal Personal Representative” (the executor of your estate) on the BDBN. This directs your super into your estate, allowing it to be distributed according to the more flexible and nuanced terms of your will. However, this carries risks. Super paid into an estate can be exposed to challenges from creditors or under a Family Provision Claim through the Victorian Administration and Probate Act 1958.
Reversionary Pensions
For your spouse, a reversionary pension is often the most seamless and effective option. When you set up a superannuation pension, you can nominate your spouse as a reversionary beneficiary. Upon your death, the pension income automatically “reverts” to them without delay or complex paperwork. This provides immediate financial continuity and gives the surviving spouse a valuable 12-month grace period before the inherited amount counts towards their own superannuation caps.
New Complications: The $3 Million Super Tax
From 1 July 2025 (or 1 July 2026), a new 15% tax on earnings applies to super balances exceeding $3 million. This “Division 296” tax adds another layer of complexity to estate planning. The tax is levied on unrealised gains, and critically, any tax loss credits the original member held are voided upon inheritance, while the tax bill for unrealised gains remains. This makes strategies like the recontribution strategy and careful management of super balances below the $3 million cap even more vital for high-net-worth Victorians.
Common Mistakes Victorian Families Make
- The “Set and Forget” Nomination: A BDBN made before a divorce could see your super go to your ex-spouse instead of your current partner or children. Nominations must be reviewed annually and after any major life event.
- Ignoring Your Will: Directing your entire $1 million super balance to one child via a BDBN while your will splits your remaining $200,000 of assets equally between your two children can cause immense family conflict. Your super and will must work together.
- Misunderstanding “Dependant”: Many assume their adult son or daughter is a “dependant.” But if they are financially independent, they are not, and will face a significant tax bill.
Protecting Your Victorian Legacy
Superannuation is no longer just a retirement savings plan; it’s a core component of modern estate planning. The interaction between Commonwealth superannuation law, federal tax law, and Victorian succession legislation creates a minefield of complexity.
Failing to plan can cost your family dearly, both in lost inheritance and emotional distress. The strategies outlined here—recontribution, BDBNs, and reversionary pensions—are powerful, but they are not DIY solutions. They require professional advice to ensure they are implemented correctly and tailored to your unique family and financial circumstances.
An investment in expert estate planning today is an investment in protecting your family’s future. It ensures the legacy you’ve spent a lifetime building passes to your loved ones efficiently and according to your precise wishes.