Death benefit tax and your super: what parents need to know

In the last 18–24 months, we’ve seen the Australian public take a marked interest in matters of superannuation. At least in part, this surge has been catalysed by a mix of front page news items, such as ASIC’s 2025 death benefit report and the saga of the Division 296 super tax proposal. It’s fair to say that the backdrop of cost-of-living concerns and interest hikes have also powered our collective interest. Clearly, we are a country with money on its mind.

In recent months, I’ve seen perhaps one of the more curious trends emerge from this interest: Growing numbers of retirees are being told by their adult children to take their money out of super to avoid the eventual super death benefits tax.

The death benefits tax applies when a person passes away and their nominated beneficiary is a non-dependent, such as an adult child. In these cases, the taxable portion of the super balance, which includes employer contributions and earnings, is taxed at 15%, plus the 2% Medicare levy, effectively making it 17%. Note that this tax only applies when the beneficiary is a non-dependent. Should the payment go to a tax-dependent, such as a spouse or a young child, it’s tax-free.

Now, what concerns me about the upward pressure adult children are placing on their parents is that it’s not only reactive and misplaced, but there’s a serious risk it’ll have an adverse effect, and in trying to thwart the tax without the backing of a well-tested financial strategy, it can end up costing a whole lot more.

Income tax and the loss of tax-free earnings within super both come into play. In some cases, the additional tax paid on the earnings of the withdrawn super over just a few years, can exceed the death benefits tax the family was trying to avoid in the first place.

A recent client case illustrates this well:

Jane* has three adult children with her late husband, John*, who passed away three years ago. Jane’s super balance is currently sitting at $5.9 million. Recently, her eldest child raised their concerns about the potentially significant death benefits tax that would be payable by Jane’s beneficiaries when she passes.

To help Jane understand the full picture and make decisions accordingly, we stepped in to model the various routes she could take with regard to accepting or avoiding the death benefits tax and the financial implications of each.

Avenue 01: Continue with Jane’s current super strategy and accept the death benefit tax

Because the death benefits tax applies to the taxable component of super, the worst case scenario would be that it’s a 17% tax on the entire balance, bringing the tax to upwards of $1 million.

However, in Jane’s case, the sum of the death benefits tax would total $265,000, which equates to less than 5% of her super balance. This has been made possible through the many years of good financial planning that have come before—planning that has included recontribution strategies which have ultimately increased the tax-free component of Jane’s super.

Avenue 02: Withdraw Jane’s entire super balance to eliminate the death benefits tax

One option on the table was for Jane to withdraw her entire super balance, effectively eliminating the $265,000 death benefits tax altogether.

However, by holding those assets personally rather than within the super environment, Jane would lose the benefit of super’s concessional tax treatment on earnings. As a result, the income generated by those assets would be taxed at personal marginal tax rates.

In Jane’s case, our analyses showed that within just three years, the additional income tax paid would exceed the death benefits tax her family was trying to avoid. Jane is only aged 70 and expects to live for many more years yet!

Avenue 03: Partially withdraw super to reduce the death benefits tax

We also explored what it would look like to partially withdraw super with the aim of reducing the eventual death benefits tax, rather than eliminating it entirely.

Under this scenario, Jane would withdraw approximately $2.9 million, bringing her super balance down to around the $3 million mark. (we were also taking into consideration the proposed Division 296 tax).

This approach did lower the death benefits tax, though the same fundamental issue remained. Even with no other income, just seven years of income tax would cost more than the death benefits tax.

In essence, the latter two strategies could “work” from a tax-saving perspective, but only if Jane passed away within the next three – seven years. Incredibly shaky ground to hinge a major financial decision on, especially considering Jane’s good health and 20+ year life expectancy.

Having laid the options out, our conversation shifted from strategies to priorities. Ultimately, it came back to the question of what mattered more to Jane: Saving tax now or saving tax later?

In the end, Jane decided that it was more important to save on tax now during her lifetime. Not only would this approach better serve her retirement goals, but it would also result in a less intense financial hit in the long run. After all, paying large amounts of income tax to avoid the death benefits tax would still eat into the amount her children stand to inherit. Maximising Jane’s income now means she can fund her lifestyle as well as paying for grandkids school fees.

While Jane’s case does well to debunk the seemingly prevailing myth that moving money out of super is a fast-track way to “save” it, the circumstances will be different for everyone. There’s no blanket strategy for sequencing your moves around the death benefits tax, because everyone’s situation—financially and otherwise—is so vastly different.

To put this into perspective, take this story from a different client. Anchored in the same issue, but the totality of circumstances are worlds apart:

Matthew* is the sole member in his SMSF. Matthew is in his late 80s and in frail health, having experienced some major medical events in recent years. His fund comes in just shy of $15 million and is mostly a taxable component, meaning we can expect his death benefits tax to total $2.2 million.

Because he recently sold down the property that was owned by the super fund, Matthew’s balance is now sitting purely in cash. Matthew is at a point in his life where he just wants to simplify. “It’s all just too hard now,” he says.

With intentions to gift a house deposit to each of his four grandchildren, with our guidance, Matthew decides to withdraw the balance of his super, understanding that doing so saves the death benefits tax but also comes with the price tag of higher income tax.

In this case, drawing out super is a perfectly appropriate decision to make, because it aligns with the totality of Matthew’s personal circumstances: he wants to simplify, he’s realistic about his life expectancy, the eventual death benefits tax would be significant, and he has a concrete plan for what he wants to do with a substantial chunk of the money he’s pulled out.

Matthew’s decision, like Jane’s, wasn’t just about tax. It was about timing and priorities. In both cases, the rules around the death benefits tax were the same, but the meaning of those rules changed once they were placed inside a real life with its own unique needs.

This is the part that often gets lost when the conversation is driven by headlines or well-meaning adult children doing mental arithmetic on someone else’s balance sheet. Superannuation is not a static pot waiting to be sliced up efficiently at the end. It is a living structure, designed to fund a life first and an estate second.

Withdrawing money purely to avoid a future tax can make sense, but only when it serves a broader purpose: simplifying, giving, spending, or responding to changes in health or capacity. When it doesn’t, it risks becoming a strange inversion, where the fear of losing money after death slowly eroding what that money could do while someone is still alive.

*Names and other identifying details have been changed to protect the individual's privacy and maintain confidentiality.

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If you’re weighing up whether to leave things as they are or make a change, Ulton Wealth can help you understand your options.

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