For many retirees, superannuation is no longer just a retirement income vehicle. It is also one of the largest assets they may leave behind to the next generation.

This creates an important planning issue. While superannuation benefits are generally tax-free when withdrawn by a member over age 60, the tax treatment can be very different when super is paid to financially independent adult children after death.

This is commonly referred to as “super death tax”. Technically, it is the tax payable on the taxable component of a superannuation death benefit when it is paid to a beneficiary who is not a tax dependant, such as an adult child who is financially independent.

For clients with large super balances, the structure of their pension accounts, the order in which benefits are drawn, and the management of taxable and tax-free components can have a meaningful impact on the wealth ultimately passed to their family.

The issue: not all super is taxed the same on death

A superannuation balance is generally made up of two key tax components:

Tax-free component – commonly created by non-concessional contributions, such as after-tax personal contributions.

Taxable component – commonly created by concessional contributions, employer contributions, salary sacrifice, personal deductible contributions and investment earnings.

During retirement, once a member is over age 60, withdrawals from a taxed super fund are generally received tax-free by the member. However, when super is paid on death to adult non-dependent children, the taxable component can be subject to tax.

This means two retirees with the same total super balance can leave very different after-tax outcomes to their children, depending on how much of their super is taxable versus tax-free.

For example, a $1 million super death benefit that is fully tax-free may pass to adult children tax-free. However, a $1 million super death benefit that is fully taxable could result in tax being deducted before the children receive the benefit.

That is why managing the components during retirement can be just as important as managing the investments themselves.

A practical example

Consider a retired couple, both aged 68, who each have large super balances and adult financially independent children.

One spouse holds two accumulation accounts:

Account 1: $1.37 million, wholly taxable.

Account 2: $1.115 million, made up of $830,000 tax-free and $285,000 taxable.

The second account is approximately 74% tax-free.

The client wants to commence account-based pensions, but the transfer balance cap limits how much can be moved into the tax-free retirement phase.

This creates a key question: should the client commence a pension from the high-tax-free account first, or from the wholly taxable account first?

Start with the high tax-free account

In most cases, where the objective is to preserve the tax-free component for estate planning, the better approach is to commence the pension from the account with the highest tax-free percentage first.

The reason is the superannuation proportioning rule.

When an account-based pension is commenced, the percentage of taxable and tax-free components is calculated at that time. Those percentages are then locked in for the life of that pension.

In this example, the $1.115 million account is approximately 74% tax-free. If that account is used to start a pension, the pension will remain approximately 74% tax-free, regardless of whether the pension balance later rises or falls.

This is powerful because if the pension grows over time, the tax-free proportion grows with it.

By contrast, if the high-tax-free account is left in accumulation phase, the tax-free component does not grow in the same way. Future investment earnings are generally added to the taxable component. Over time, this can dilute the tax-free percentage.

In simple terms, the tax-free account is better protected in pension phase than in accumulation phase.

How the pension could be structured

If the general transfer balance cap is $2 million, the client could use the full $1.115 million high-tax-free account to commence one pension, and then add a further $885,000 from the wholly taxable account to commence a second pension.

This would use the full $2 million transfer balance cap and leave $485,000 of the wholly taxable account in accumulation phase.

If the pension is commenced after 1 July 2026, when the general transfer balance cap increases to $2.1 million, the client could use the full $1.115 million high-tax-free account and add $985,000 from the wholly taxable account. This would leave $385,000 of the wholly taxable account in accumulation phase.

The exact numbers depend on the client’s personal transfer balance cap at the time the pension is commenced.

Why keeping two pensions can make sense

Some clients are tempted to combine everything into one pension for simplicity. While this may be administratively easier, it can reduce flexibility.

In this case, there may be a strong estate planning reason to keep two separate pensions:

Pension 1: the high-tax-free pension.

Pension 2: the wholly taxable pension.

This structure provides more control over which component is drawn down over time.

If the client only takes the minimum pension payments, both pensions will need to pay their required minimum each year. However, if the client needs more than the minimum, they can choose to take the extra drawings from the taxable pension first.

That helps reduce the taxable component during the client’s lifetime, while preserving more of the tax-free component for the next generation.

If the two pensions are blended into one account, every payment must come out in the fixed taxable and tax-free ratio of that pension. The client loses the ability to deliberately draw down the taxable component first.

For estate planning, that control can be valuable.

The order of drawdowns matters

For clients trying to reduce death benefits tax, the broad strategy is usually to draw down taxable super first and preserve tax-free super where possible.

The practical order may look like this:

First, draw any surplus retirement needs from taxable accumulation money.

Second, once the taxable accumulation balance has been reduced, draw additional amounts from the taxable pension.

Third, preserve the high-tax-free pension as much as possible, subject to the required minimum pension payments.

This approach recognises that taxable super may be tax-free in the member’s own hands while they are alive, but taxable if left to adult non-dependent children on death.

Put simply: every dollar of taxable super withdrawn during life is a dollar that cannot be taxed as a death benefit later.

The challenge as clients get older

A practical issue emerges as retirees age.

Account-based pension minimum drawdown rates increase with age. As the client gets older, the required pension payments may become larger than the amount they actually need to spend.

This can create a problem where the client is forced to draw down their tax-free pension, even though they would prefer to preserve it for their children.

At that point, it may be worth reviewing the structure. Depending on the circumstances, one option may be to commute or partially commute a pension back to accumulation phase, or restructure the pension accounts to ensure taxable balances are being drawn down first.

However, this needs to be handled carefully. Commutations can affect transfer balance account reporting, pension documentation, estate planning nominations and the client’s broader strategy.

This is not something that should be done casually or without advice.

What about commuting and restarting the pension later?

Some retirees wonder whether they can allow their pension to grow above the transfer balance cap, commute it back to accumulation, and then start a new pension up to the cap again.

In most cases, this does not provide the benefit they expect.

The transfer balance cap limits the amount that can be transferred into retirement phase. It does not prevent investment growth within an existing pension account. If a pension starts with $2 million and later grows to $2.3 million due to investment returns, the excess growth can remain in pension phase.

Commuting and restarting the pension does not allow the client to “refresh” the cap or move more money into pension phase if they have already fully used their personal transfer balance cap.

In fact, it may simply add complexity, administration and potential reporting issues without improving the tax outcome.

The spouse position

Where both spouses have similar balances, the strategy should be reviewed for each person separately.

A super death benefit paid to a spouse is generally not subject to the same death benefits tax issue, because a spouse is a tax dependant. The larger issue often arises on the death of the second spouse, when remaining super is ultimately paid to financially independent adult children.

This means both spouses should consider the long-term structure of their super, not just their own retirement income needs.

The aim is not necessarily to remove all money from super. Super can remain a highly tax-effective retirement structure. The aim is to manage the components intelligently, so that taxable balances are used during life and tax-free balances are preserved where possible.

Key planning points

For retirees with large super balances and adult children, the following points are important:

Start pensions from high-tax-free accounts first where the goal is to preserve tax-free components.

Consider keeping separate pensions where different accounts have different tax components.

Use taxable accumulation balances and taxable pensions first for additional withdrawals.

Review the strategy regularly as pension minimums increase with age.

Do not assume that commuting and restarting pensions will improve the transfer balance cap outcome.

Ensure binding death benefit nominations, reversionary pension arrangements and estate planning documents are aligned.

Cadre Capital Partners’ view

For high-net-worth retirees, retirement planning and estate planning should not be treated separately. The way superannuation pensions are structured can affect retirement income, tax, investment flexibility and the amount ultimately received by beneficiaries.

The key is not just how much super you have, but what type of super you have.

A retiree with a large tax-free component has a valuable estate planning asset. Preserving that component requires deliberate structuring and disciplined drawdown planning.

For clients with balances above the transfer balance cap, the decision is rarely as simple as “start a pension”. The better question is: which pension should be started, from which account, in what order, and how should withdrawals be managed over time?

This is where personalised advice can make a meaningful difference.

If you would like to review your superannuation, retirement income strategy or estate planning position, please contact Cadre Capital Partners.

Our team can help assess whether your pension structure, taxable and tax-free super components, binding death benefit nominations and broader estate planning strategy are aligned with your long-term objectives.