When a self-managed super fund (SMSF) holds life insurance for its members, the proceeds of that policy are paid to the fund when a member dies. While those proceeds are not taxed in the SMSF, they can still have important downstream tax consequences for beneficiaries.
In particular, where the SMSF has claimed deductions for life-insurance premiums or elects to claim a future-service deduction, the payment of a death-benefit lump sum can give rise to an “element untaxed in the fund” under section 307-290 of the Income Tax Assessment Act 1997 (ITAA 1997).
What the legislation says
Section 307-290 applies specifically to a superannuation death benefit that is paid as a lump sum.
The section states that if:
the lump sum includes an amount representing an insurance payment, and
the fund has claimed or intends to claim a deduction for that insurance (either as an annual premium deduction under s 295-465 or a future-service deduction under s 295-470),
then the taxable component of the death-benefit lump sum must be split into two parts:
Element taxed in the fund, and
Element untaxed in the fund.
The “untaxed element” is effectively the portion of the lump sum that relates to deducted insurance, because the fund has already received a tax benefit for those premiums.
How the calculation works
Step 1: Taxed element = Total lump sum x Service days/(Service days + Days to retirement) – Tax free component
Step 2: Untaxed element = Taxable component – taxed element
If no deduction (or future-service deduction) has been or will be claimed, no untaxed element arises — the entire benefit is treated as element taxed in the fund.
When it applies — lump sums only
Section 307-290 applies only to lump-sum death benefits, not to pensions (income streams).
If the death benefit is paid as a pension to a dependant, it is taxed under the normal pension-tax rules based on the ages of the deceased and the recipient. No s 307-290 untaxed-element calculation applies in that case.
Why it matters for beneficiaries
The untaxed element determines how the recipient of a lump-sum death benefit is taxed:
| Recipient | Tax treatment |
|---|---|
| Tax dependant (e.g. spouse, minor child) | Lump sum is tax-free, including any untaxed element. |
| Non-dependant (e.g. adult child) | Taxable component – element taxed at 15% + Medicare levy. Element untaxed at 30% + Medicare levy. |
The higher 30 % rate on the untaxed element is designed to ensure that insurance proceeds — for which the fund has already received a tax deduction — are taxed once before leaving the super system.
Avoiding confusion: what doesn’t create an untaxed element
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TPD or terminal-illness benefits: These are paid to the member personally, not as death benefits, and are covered by other provisions (such as the disability tax-free uplift in s 307-145). They do not give rise to an untaxed element.
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Death-benefit pensions: Section 307-290 does not apply. The benefit is taxed under Division 302 depending on ages.
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No deductions claimed: If the fund never claimed or intended to claim a premium or future-service deduction, the insurance proceeds remain fully taxed inside the fund and no untaxed element is created.
In summary
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The untaxed element only arises for lump-sum death benefits where the fund has claimed (or intends to claim) insurance-related deductions.
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Dependants receive the lump sum tax-free; non-dependants may pay up to 30% + Medicare levy on the untaxed portion.
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No untaxed element applies to pensions or disability benefits.
Understanding how the untaxed element is calculated ensures trustees and advisers can correctly classify benefits, meet their compliance obligations, and communicate accurate outcomes to beneficiaries.
Futher reading: ATO ID 2010/76.
Read our article: Superannuation Tax Components Explained: Tax-Free vs Taxable.