A death benefit paid as a lump sum to a dependant of the deceased is tax free. It's not assessable income or exempt income, so the SMSF doesn't withhold tax from the payment and the recipient doesn't include it in their income tax return.

For income tax purposes, a person is a dependant of a deceased member if, at the time of the member’s death, that person was:

• the deceased’s spouse (or former spouse)
• the deceased persons child (aged less than 18)
• any other person with whom the deceased had an interdependency relationship
• any other person who was wholly or substantially financially dependent on the deceased just before they died.

If the death benefit is paid as an income stream or is paid to a non-tax dependant beneficiary there may be tax plus the Medicare levy to pay. Your SMSF will need to determine the taxed and untaxed elements of the benefit, calculate the applicable tax and, if appropriate, withhold tax from payments. The taxable component of a super benefit may consist of an element taxed in the fund or an element untaxed.

For more information, see death benefits on the ATO website.