In short

When an employee dies in service, the employer's termination payment (accrued leave, notice pay, ex-gratia amounts) is a death benefit ETP. Paid to a dependant, such as a spouse or minor child, it's tax-free within the $260,000 FY25-26 ETP cap. Paid to a non-dependant, such as an independent adult child, it's taxed at 32% within the cap, and 47% above it either way.

When an Australian employee dies during their employment rather than after retiring, their employer typically makes a termination payment to the deceased's family or estate — covering accrued unused leave (annual leave, long service leave), payment in lieu of notice, ex-gratia or goodwill payments recognising the employee's service, and other amounts arising from the termination of the employment relationship. These payments are categorised as death benefit Employment Termination Payments (death benefit ETPs) under Division 82 of the Income Tax Assessment Act 1997, and they have different tax treatment from the ordinary "life benefit" ETPs that apply when an employee terminates employment while alive — retirement, redundancy, resignation. For families dealing with a member's death in service — and for pre-retirees planning their own estate for the possibility — understanding the death benefit ETP framework is essential to ensuring that the tax treatment is applied correctly and the family receives the maximum after-tax benefit from a situation that is otherwise entirely about loss.

The fundamental distinction between life benefit and death benefit ETPs centres on the cap that applies and the rates that apply within and above it. Both types use the ETP cap, which for FY25-26 is $260,000. Above the cap, both attract the top marginal rate of 45% plus 2% Medicare levy — 47% effective. The two caps run separately for a given recipient — a person can have life benefit ETPs and death benefit ETPs that each use their own ETP cap. The key difference is in the rate within the cap: for a death benefit ETP paid to a dependant of the deceased, the amount within the cap is effectively tax-free. For a death benefit ETP paid to a non-dependant, the amount within the cap is taxed at 30% plus 2% Medicare levy — 32% effective. The death benefit framework produces a more concessional outcome for dependants (0% vs 17% for living-employee ETPs) and a less concessional outcome for non-dependants (32% vs 17%) than the equivalent living-employee scenario.

The death benefits dependant definition under section 302-195 of the ITAA 1997 — picked up by Division 82 for ETP purposes — is the gating concept for the favourable treatment. A dependant of the deceased is the deceased's spouse or former spouse; a child of the deceased aged under 18; a person who was financially dependent on the deceased at the time of death; or a person in an interdependency relationship with the deceased at the time of death. The same definition applies to super death benefits — meaning the analysis of who is and isn't a dependant flows across both the super and the ETP regimes consistently. For typical families, the surviving spouse and any minor children are dependants; adult children are dependants only if they were financially dependent on the deceased (which for most independent adult children is not the case). Documentation of the relationship — particularly financial dependence for adult children, or interdependency for less-traditional family structures — is essential to claiming the favourable treatment.

The payment components that constitute a death benefit ETP are typically multiple. Unused leave payouts — accrued annual leave and long service leave that the deceased had earned but not taken — flow as part of the death benefit ETP. Payment in lieu of notice — where the deceased was entitled to notice that they could not serve because of their death — is included. Ex-gratia and goodwill payments — discretionary employer payments recognising the deceased's service and the family's loss — are included. Severance or redundancy components — where the deceased was being made redundant at the time of death — are included (with potential interaction with the genuine redundancy tax-free amount). What is not a death benefit ETP: super death benefits (paid by the super fund directly under separate rules); life insurance proceeds paid directly to the family by the insurer where the family is named as the policy beneficiary (the insurance company pays the family, not the employer); and lump-sum bereavement assistance from Centrelink. Distinguishing these streams is important because each one has its own tax framework, and ETPs are only one piece of the financial picture.

The practical tax outcomes for dependants are highly favourable. A surviving spouse receiving a $200,000 death benefit ETP — comprising, say, $80,000 of accrued leave, $40,000 of payment in lieu of notice, and $80,000 of ex-gratia payment — pays no tax on the entire amount (it is all within the $260,000 cap for FY25-26). The payment is reported on the spouse's tax return as a death benefit ETP but the 0% rate produces no tax payable, and no PAYG should have been withheld at source. For larger payments — say a $400,000 death benefit ETP — the amount within the cap ($260,000) is at 0%, but the excess ($140,000) is taxed at 47% (top marginal + Medicare), producing about $66,000 of tax. The cap is therefore highly material for senior executives with substantial accrued entitlements.

The practical outcomes for non-dependants are less favourable but still concessional. An adult child (not financially dependent on the deceased) receiving a $200,000 death benefit ETP pays approximately $64,000 in tax (32% effective rate). For larger payments, the excess above the cap attracts 47% just as for dependants. The non-dependant treatment is still meaningfully better than the marginal-rate alternative (the same $200,000 added to a working adult child's ordinary income would attract a much larger combined tax bite at their personal marginal rate) — but the contrast with the dependant 0% rate is stark. For families with mixed dependants — typically a surviving spouse plus adult independent children — the distribution of the death benefit ETP among beneficiaries materially affects the family's combined tax outcome: directing the payment to the dependant spouse produces the most efficient result, but splitting can be useful when the spouse's share would otherwise exceed the cap.

The estate vs direct payment structure affects the tax characterisation in important ways. Where the employer pays the death benefit ETP to the deceased's estate (the legal personal representative), the estate then distributes to the will's beneficiaries. The tax treatment within the estate depends on whether the ultimate beneficiaries are dependants or non-dependants of the deceased — and the executor must trace each component through to claim the dependant 0% rate where it applies. Where the employer pays directly to nominated beneficiaries — typically possible where the employment contract or employer policy provides for nominated death-benefit recipients — the tax treatment applies according to each recipient's status. Direct payment to a dependant spouse is typically the most tax-efficient structure because the 0% rate is applied immediately at source with no withholding. Payment via the estate is administratively simpler but can delay the tax outcome and, in some structures, complicate the dependant analysis where beneficiaries are mixed. The related area of superannuation proceeds trusts handles a similar dependant-vs-non-dependant analysis on the super side.

What do worked planning examples show?

These two cases show how death benefit ETPs apply. Illustrative only — not personal advice — using FY25-26 figures.

Case 1 — David, 58, senior corporate executive, dies suddenly while still in employment. He is survived by his wife Susan (55) and two adult children (28 and 31, both financially independent). David had accrued $90,000 of leave and his contract entitled the family to a $150,000 ex-gratia payment on death in service. There is no employer-held life insurance in the picture (his personal life insurance is paid directly to Susan by the insurer outside the ETP). On these facts the death benefit ETP totals $240,000 ($90,000 leave + $150,000 ex-gratia), which is within the $260,000 FY25-26 ETP cap. If the entire $240,000 is paid directly to Susan as a dependant spouse, the tax on the ETP is nil — all within her cap at the 0% rate. If instead the payment is split equally three ways — Susan, the 28-year-old child, and the 31-year-old child — Susan's $80,000 share is at 0% (within her cap, dependant), and each adult child's $80,000 share is taxed at 32% within their own cap (~$25,600 each, $51,200 combined). On these facts the rational structure is to direct the payment to Susan; splitting only makes sense when the dependant's share would otherwise exceed the cap, which is not the case here. The conversation with the employer should establish the structure — most employers will follow the family's stated preference, given there is no operational reason to insist on a split.

Case 2 — Margaret, 62, accountant, dies in service. She was widowed five years ago, with no current spouse. She has one adult child Karen (32), who is financially independent. Margaret's accrued leave totalled $35,000 and her contract had no ex-gratia provision. On these facts the death benefit ETP is $35,000, well within the ETP cap. Karen is the sole intended beneficiary via the estate. Karen is a non-dependant (adult, financially independent), so the ETP is taxed at the 32% non-dependant rate within the cap: approximately $11,200 of tax, leaving Karen with about $23,800. There is no scope for the spread-among-multiple-beneficiaries strategy that helps when the cap is the binding constraint — the cap isn't binding here, and Karen is the sole heir. The general point this illustrates is that the dependant/non-dependant distinction is the dominant variable for typical-size death benefit ETPs — when no dependant is present, the 32% concessional rate applies (better than marginal rates for a working adult, but a long way from the 0% that a dependant would receive on the same payment).

For families dealing with an in-service death, the death benefit ETP framework is one of the financial mechanisms that operates alongside super death benefits, life insurance, estate administration, and the broader practical and emotional challenges. The advice work is to engage with the employer on what is being paid and how it is being characterised, confirm dependant status with appropriate documentation, advise on the optimal payment structure (direct to dependants versus via the estate with onward distribution), coordinate with super death benefit administration and estate planning, and ensure the employer's PAYG withholding reflects the correct concessional rates (0% to dependants, 32% to non-dependants within the cap, 47% above). For pre-retirees planning their estate, the death-in-service scenario is one of the lower-probability but higher-magnitude events estate planning should address — particularly for high-income executives with substantial accrued entitlements where the $260,000 ETP cap can become a real constraint.

Sources

Key takeaways

  • A death benefit ETP paid to a death benefits dependant — a spouse, minor child, financial dependant, or interdependency partner — is entirely tax-free within the ETP cap ($260,000 for FY25-26).
  • The same payment made to a non-dependant, such as a financially independent adult child, is taxed at 32% within the cap instead of the 0% dependant rate.
  • Amounts above the ETP cap are taxed at 47% regardless of dependant status, so the cap becomes a real constraint for senior executives with large accrued entitlements.
  • Super death benefits, life insurance proceeds paid directly by the insurer, and Centrelink bereavement assistance are all separate from a death benefit ETP and follow their own tax rules.
  • How a death benefit ETP is distributed among mixed beneficiaries (a dependant spouse plus independent adult children) materially affects the family's combined after-tax outcome.

Frequently asked questions

Is a death benefit ETP paid to a spouse taxed?

Generally no, as long as it falls within the ETP cap ($260,000 for FY25-26). A spouse is a death benefits dependant, so the entire amount within the cap is effectively tax-free; only any amount above the cap is taxed, at 47%.

How much tax does an adult child pay on a death benefit ETP?

If the adult child is financially independent — not a dependant of the deceased — the amount within the ETP cap is taxed at 32% (30% plus 2% Medicare levy). This is still more concessional than ordinary marginal-rate tax, but far less favourable than the 0% rate that applies to a dependant like a spouse or minor child.

Does accrued leave paid out after someone dies at work count as a death benefit ETP?

Yes. Unused annual leave, long service leave, payment in lieu of notice, and any ex-gratia or goodwill payments the employer makes because of the death all form part of the death benefit ETP, taxed according to the recipient's dependant status.

If a family includes both a spouse and independent adult children, how should a death benefit ETP be split?

Directing the payment to the dependant spouse is usually the most tax-efficient approach, since it's taxed at 0% within the cap, versus 32% for the non-dependant adult children's share. Splitting the payment across multiple beneficiaries generally only makes sense if the spouse's full share would otherwise exceed the ETP cap.

A note on advice. This article is general information only and doesn't account for your personal circumstances. Everyone's situation is different — before acting, it's worth talking it through with a licensed adviser who knows your full picture.